To truly assess investment risk, Tassos Stassopoulos believes you need to place yourself at a future point in time and imagine that you’ve already failed. From that perspective, he says, you have a much better vantage point to envision all the things that could have gone wrong.
The founder, managing partner and CIO of Trinetra Investment Management, in the UK, admits that assuming failure might seem like a counterintuitive way to invest for growth.
“But it’s an effective way to avoid behavioural biases and to objectively value companies,” he argues.
Analysts tend to get “blurry-eyed” in the face of exciting investment narratives, Stassopoulos says, and “98 per cent” of the stock review ends up being about all the amazing things that will happen if the investment works. At this stage, he says, the idea that things might go wrong is more of an afterthought.
“Analysts will tell you things that imply it’s not their fault if things go wrong; it’s [US President Donald] Trump, it’s macro, it’s political, it’s the exchange rate…”
Stassopoulos explains that his methodology leans heavily on research dating back to the 1980s that employed a “temporal perspective”, which has at its heart the notion that you get completely different outcomes if you look at events from different points in time.
“Look at it like this,” he says. “What is the chance that in August you won’t have your current job? You might say that it’s unlikely because you like your job and you’re performing well so it won’t happen. Then I tell you it’s August; I’ve just met you and you no longer have that job. If I ask you to tell me what went wrong, a different part of your brain will work. You will have to start thinking about all the things that bothered you about the job. The pay, the people, whatever. The perspective is completely changed.”
The methodology Stassopoulos uses emulates failure before it happens, and attempts to categorically assess all the things that may have contributed to that failure. A pre-mortum, if you will.
“We tell analysts to project themselves three years into the future and imagine the investments have failed,” Stassopoulos says. “And we ask them to write the explanation of the failure.”
The benefit here is that you don’t get a loose statement, he explains. What you get is real scenarios about what went wrong.
“The discussions are very different,” he says.
The probability of these events occurring is less important, he says, than making sure you identify them.
“Between materiality and probability, materiality is what’s more important,” Stassopoulos says. “A high-probability, low-materiality risk is a nuisance; it happens and you’re going to have to deal with it, but it doesn’t matter. It’s not material. A highly material risk that is probably not going to happen, but does – that’s a black swan event.”
Investors, advisers and analysts should be imagining all material scenarios, or “black clouds of risk”, that could affect investments, Stassopoulos warns. To do less is tantamount to a red flag.
“When you go to management and you ask the CFO about the top risks and they say. ‘Yeah, I don’t remember, but I think cyber-security is one of them’… these are not the guys that we are going trust with our money or our investment,” Stassopoulos says. “Risk shouldn’t be an afterthought. That, in turn, is a risk for us. These aren’t the people we want as guardians of our assets.”
Stassopoulos will speak at the Portfolio Construction Forum’s Finology Summit at Carriageworks in Sydney on February 20-21.
