The Reality of the Unknown
The past few months have given investors a valuable reminder of the importance of diversification and to be humbly aware of just how often the unpredictable can occur.
In January 2010, a portfolio containing British Petroleum (BP) and Hewlett Packard (HPQ) would not have raised any concerns as these have both been respectable performers. Under Mark Hurd’s leadership starting in April 2005, HP’s profit more than tripled, sales increased 32% through 2009 and the stock price rose admirably. It would have been impossible to predict either the Deepwater Horizon incident or Hurd’s rather sudden and soap opera-like departure from HP. In the months after the Deepwater incident, BP’s market stock price plummeted by over 50% to its lows in July. Within minutes of the news of Hurd’s departure, the company’s stock market value fell by nearly $10 billion.
This serves as a strong reminder to be highly aware of just how much you cannot predict, just how much is truly unknowable. Life is full of the unexpected. I like Nassim Taleb’s view on this in that “black swan” events occur much more often than we are aware. Risk management involves managing knowable, measurable risks. Loss mitigation is about all the things you didn’t even imagine could happen, let alone be able to quantify. Successful investing requires both and the ability to differentiate between the two.
