The Investment Scientist

Posts Tagged ‘agency risk

images-54Recently, a prospective client of mine sent me an email asking about my thoughts on Bill Bernstein’s new book “Deep Risk.” I have not read the book yet, but I do have my own ideas about deep risk vs shallow risk.

I define shallow risk as a potential loss that you can recover from and deep risk as a loss that you cannot recover from.

Market volatility, for example, is a shallow risk. It is very visible and it is scary, there is even a TV channel devoted to it. (That TV channel is called CNBC.)

But taking on shallow risk is how you earn your investment keep. Thus, it should not be feared, it should be welcomed.

Now what are the deep risks you should ardently avoid? I can think of three: inflation risk, behavior risk and agency risk.

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When talking to a prospect about my advisor services, I would ask him his philosophy about risk. The conversation would usually go like this:

Prospect: “I don’t like losing money.”
Me: “What do you mean? Can you be more specific?”
Prospect: “I don’t mind giving up a little upside; I just don’t want to lose too much on the downside.”
Me: “So you are concerned about volatility risk?”
Prospect: “That’s it.”
Me: “Other than that, are there risks you are concerned about?”
.. (long pause)
Prospect: “Not that I can think of.”

It is not surprising that most investors equate investment risk to volatility; they see assets prices (and their portfolio values) fluctuate every day. But there is much more to investment risk than what meets the eye. And what investors don’t see usually is far more insidious. For example:

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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