The extinction of prudence

We are living through a period of wide-spread crazy. Sure there have always been reckless factions in the world. But today the affliction is mainstream. A good many people see what is happening and know that it is likely to end in more financial pain and human suffering, but most say that they are opting to play along anyway. The most common justification given, is that current monetary policies are nuts but so long as the music is playing one has to keep dancing. Famous last words of Chuck Prince who was head of Citigroup as the firm imploded in 2008: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” he said on the eve of his firm’s collapse.

There is a similar lemming-like sentiment at the moment in investment managers and strategists. Many are ignorant or self-deluded. But even the ones who know better have decided that it is a fool’s game to fight the Fed–better to throw client capital like craps at the casino and cross your fingers. The risk of destroying capital is trumped by the risk of looking like they are missing out on short-term gains–regardless of how fleeting.

I can think of a thousand analogies for this mentality. Driving fast on spring ice, hoping you can gun it over open water. Huddling in a burning building ’cause it’s warm. Just because people chose to do it, doesn’t mean it’s prudent, wise or not likely to be deadly. It’s a matter of when–not if.

The fact is that valuable risk managers are hard to find. Hard to find because it is hard to do. Sticking to rational controls and insisting on favorable odds requires discipline, on-going care and attention. Periodically it requires self-sacrifice. To be useful and worthy of trust, one must do what is best for those whom they are charged to protect, rather than what is easiest, self-enriching, consensus or short-term popular. This goes for parents. And it goes for politicians, trustees, business owners and asset managers.

Over the past 15 years, reckless policies in the western world have facilitated the extinction of prudence. We are all paying for that now. Given the thinking still dominating, it seems most will continue to pay for a while longer still.

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7 Responses to The extinction of prudence

  1. michael says:

    Extraordinary Popular Delusions & the Madness of Crowds …… like the crown and anchor wheel at the carnival, where she stops no one knows.

  2. Ralph Parry says:

    You do have a way with words Danielle.

  3. John C says:

    From my experience dealing with financial advisors and portfolio/fund managers (both in the bank-broker model and mutual fund industry) has shown that two things are paramount. Sales of funds (mutual funds and ETFs) and relative performance.

    I think what keeps the typical portfolio/fund manager up at night most of all is the fear of under-performing his/her peers. While alpha is important to them (at least ostensibly), what really matters is how their funds performed relative to the competition.

    From their perspective, it seems, it is better for them to always be fully, or almost fully, invested in the markets because they will look incompetent if they miss out on gains. And if they happen to lose money in a correction, that’s not good, but it’s OK because so will everyone else. In other words, they all sink or swim together. This approach essentially removes choice for the average client-investor because differences in managers and advisors are largely smoothed out.

    Another way they avoid risk (and thus risks to their careers) is by basically shadowing an index. To readers: Have you ever actually seen the holdings in a typical fund? The rationale is that diversification lowers risk, but the real reason they do it, I suspect, is because it’s the safe approach.

    Then of course, you have the sales side, which plays a crucial role. You can’t have an army of salespeople bringing in a stream of cash and not buy stuff with it. So, these people have two major forces pushing them to ‘put the money to work.’

    I think there are a lot of smart people in this business, but the structure of the business and the kind of behaviours it encourages are bad for investors. The system is bad. And a bad system with good people will get bad results. It’s better to be lucky than smart. As Danielle has pointed out many times, the name of game is sales, not management.

    Danielle, you are a minority in this business. You actually manage risk for your clients, where most portfolio managers manage risks to their careers and their employers’ bottom lines. I can see how being a true fiduciary can be a very tough job during periods when markets are being pumped up by wishes and dreams and cheap money, rather than by reality. Thanks for steadfastly sticking to your guns and reminding people what real investing and risk management is about.

  4. michael says:

    On topic….. although I do detest his swagger and his ignorance in the use of derogatory language at the expense of the innocent this “player” adds some colour here.
    When the eventual pullback comes rest assured it will be bot with both hands and feet.

  5. Tony Hladun says:

    What we’re experiencing is the norm not the exception.

    “A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves money from the Public Treasury. From that moment on, the majority always votes for the candidate promising the most benefits from the Public Treasury with the result that a democracy always collapses over loose fiscal policy always followed by dictatorship.”

    Alexander Fraser Tyler, “The Decline and Fall of the Athenian Republic”

  6. aliencaffeine says:

    So, I guess it is gamble on, keep piling up chips and PRUDENTLY whisk a healthy portion off to safe harbor, right?

    Gambling is okay, as long as you understand the rules and control yourself.

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