“Hard work pays off in the future. Laziness pays off now.” - Steven Wright
Donuts. Heroin. Drunk driving. Unprotected sex. Speed bumps. For those who choose to partake, they all offer immediate gratification, but at a tremendous cost over time. There is a wide divide between what feels good to you and what is good for you. I choose to abstain from all of the above. I assume the first four in my list are self-explanatory, so I will concentrate on the fifth -- Speed Bumps.
The speed bump is a generally accepted risk management tool. Essentially it serves as a line in the sand which triggers a specific reaction. As an example, if a portfolio manager is down 5% from the high water mark (HWM; peak profit), then her risk is halved. If it happens again, risk is halved again, and so on. It's one of those things that sounds good in a marketing presentation, allowing a fund manager to masquerade as a disciplined risk manager. The problem is that its mere existence creates an impediment to thinking deeper about and implementing more effective, proactive risk management procedures. Worse yet, speed bumps ultimately serve two distinct purposes. They reduce the returns of a good investment manager and they extend the life of a poor one. The better the manager, the more dramatic the negative impact, and vice-versa.
See the chart below for an example of how the speed bump serves to crush a good manager's returns. In this example, Steve Jobs is the PM and Apple stock is his portfolio. Using an initial investment of $10,000 when Jobs returned in ’97 and letting it run until he retired in 2011 would have left you with stock worth nearly $900,000. If, however, Steve had opted to employ a 10% speed bump, the portfolio would have been worth nearly 90% less. The CIO who elects to implement the speed bump should own that $800,000 loss. I know what you’re thinking. By employing this generally accepted risk management procedure he will have dramatically reduced the volatility of returns. Actually, it would have gone down from 50% to 38%, so yes, some improvement. What’s the benefit of less volatility? Theoretically, you could apply a commensurate amount of leverage to the investment, thereby producing an even better net result. Unfortunately, that isn’t even close to the reality (see faded red line in chart below).
I know what you’re thinking now. Not every PM is Steve Jobs. True, but in every case where the PM is a positive performer, your returns will be better without a speed bump. What about the poor performer? Simply stated, you should fire him.
Ultimately, speed bumps are a risk management placebo. That’s not how I would choose to treat a condition that could prove fatal. Instead, I prefer the harsh taste of discipline, transparency, planning, investigation, and thorough analysis; a far more appropriate prescription for the ailments we face.
The Managing vs Marketing of Risk “You can take risk. Just don't lose money." - A Former Boss Risk management seems like a simple endeavor. It’s not. It requires a deep understanding of what risk is and how it can be managed. Some think that simply being strong is the answer. It’s not. Many think of risk as something you deal with after the fact, and it shows in their pitch. “I will force positions to be shut down.” “I will step in and close positions myself.” “We will cut risk...” All of these statements reflect a reactive risk management process. While they sound tough and disciplined, they are really just impulsive behaviors attempting to clean up impulsive behaviors, after the damage has already been inflicted. Fact is, the biggest hedge fund disasters don’t occur when funds are doing poorly. They come about when they are doing well, and risk management has been sidelined. That’s why every loss and every gain attracts my interest in exactly the same way, for the most effective risk management is both proactive and consistent execution.
Wishful Thinking "People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome.” - George Orwell
The Blind Leading the Blind “There is almost nothing more convincing, than a live human being who takes the stand, points a finger at the defendant, and says, 'That's the one!' The problem is that our justice system hasn't adapted to what modern forensic science has established about memory's failings. Judges and juries tend to give too much credence to eyewitnesses, particularly those who appear confident of their memories and are seen as having little motive to lie.” - U.S. Supreme Court Justice William J. Brennan
The first school I heard back from when I applied to graduate school was George Washington University. It was a rejection and I was devastated. How that information affects your judgment of my intelligence or what my true potential may be, is a function of whether you were standing beside me when I opened the letter or hearing about it for the first time right now, nearly 23 years later. So many other factors also come into play, such as how you rate GWU’s graduate business program. However, most of those factors have little to do with me. They are simply a way to help you compartmentalize me. As I provide more color, inevitably I will shift from one compartment to another inside your brain. There’s a good chance I may even shift GWU, and a few other institutions, around in there too.
Truth is, GWU was my backup, my failsafe. The fact that I received their response first is what made it so devastating. After all, if I didn’t get into George Washington University’s School of Business, what hope did I have for Harvard, Columbia, Wharton and NYU; the only other schools to which I had applied? I felt foolish and ashamed. Clearly I’d had a higher opinion of myself than was warranted. Then one by one, every other school responded with an acceptance letter, and with each acceptance, belief in myself improved. My stock, in the eyes of others, was also on the rise. That rejection letter went from being a source of embarrassment for me, to what I believed should have been a source of embarrassment for GWU. But what if GWU was the only school to which I had applied? What if it was my brass ring selection? While I would still have been the same candidate with the same potential in any of those cases, how I, and others, viewed me for the rest of my life would likely have been radically transformed. I decided at that moment, it would be the last time I would outsource my opinion of myself, and of others. The truth is, whatever someone says to you about another person is skewed from the start. It comes through their filter, their likes and dislikes, their education, their ambition, and the leanings of their own mind. In the end, admissions officers, references and even eyewitnesses, are poor substitutes for the facts.
About the Author For nearly thirty years, Stephen Duneier has applied cognitive science to investment and business management. The result has been the turnaround of numerous institutional trading businesses, career best returns for experienced portfolio managers who have adopted his methods, the development of a $1.25 billion dollar hedge fund and 20.3% average annualized returns as a global macro portfolio manager.
Mr. Duneier teaches graduate courses on Decision Analysis in the College of Engineering, as well as Behavioral Investing, at the University of California.
Through Bija Advisors' coaching, workshops and publications, he helps the world's most successful and experienced investment managers improve performance by applying proven, proprietary decision-making methods to their own processes.
Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America, Managing Director in charge of Emerging Markets at AIG International and founding partner of award winning hedge funds, Grant Capital Partners and Bija Capital Management. As a speaker, Stephen has delivered informative and inspirational talks to audiences around the world for more than 20 years on topics including global macro economic themes, how cognitive science can improve performance and the keys to living a more deliberate life. Each is delivered via highly entertaining stories that inevitably lead to further conversation, and ultimately, better results.
His artwork has been featured in international publications and on television programs around the world, is represented by the renowned gallery, Sullivan Goss and earned him more than 50,000 followers across social media. As Commissioner of the League of Professional Educators, Duneier is using cognitive science to alter the landscape of American K-12 education. He received his master's degree in finance and economics from New York University's Stern School of Business.
Bija Advisors LLC In publishing research, Bija Advisors LLC is not soliciting any action based upon it. Bija Advisors LLC’s publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Bija Advisors LLC does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Bija Advisors LLC’s publications only. All forecasts and statements about the future, even if presented as fact, should be treated as judgments, and neither Bija Advisors LLC nor its partners can be held responsible for any failure of those judgments to prove accurate. It should be assumed that, from time to time, Bija Advisors LLC and its partners will hold investments in securities and other positions, in equity, bond, currency and commodities markets, from which they will benefit if the forecasts and judgments about the future presented in this document do prove to be accurate. Bija Advisors LLC is not liable for any loss or damage resulting from the use of its product.