Risky business

Attempts to eradicate risk from investment are neither practical nor desirable

by . .

Amy Carroll

Amy Carroll


A cultural and political obsession with eradicating risk – both personal and financial – threatens to asphyxiate 21st-century living.

Whether it’s leaving our children to rot in front of the Playstation rather than “risk” the terrors of stranger danger; enforcing smoking bans so we can be saved from our own vices, or imposing ill-conceived risk management regulation on the private equity industry – a la AIFM – removing the freedom to fail just doesn’t make good common, or economic, sense. 

Now, nobody is suggesting that we should let the monumental failures of the past few years go by unremarked. The consequences have been catastrophic and there are, of course, lessons to be learned – although there is also the very real danger that we will become so caught up in historical indiscretions that we will fail to see the next blow-up coming until it hits us full in the face. But in any case, risk, and by extension failure, has its own Darwinian role to play. 

As that connoisseur of risk Warren Buffett said: “Risk comes from not knowing what you are doing.” And as the father of history, Herodotus, said some 25 centuries earlier: “Great deeds are almost always wrought at great risks.” The same, perhaps, could be said of great deals.

That risk is lauded when it involves backing a handful of tech nerds in Silicon Roundabout or Berlin, of course. But it is lambasted when it comes to fuelling the vital growth of Europe’s mid-sized companies.

Granted, the risks involved are rather different – the sums somewhat larger and, thanks to the labyrinthine structured products that evolved at the peak of the market, having a far wider impact. 

Those risks must be recognised and managed. And admittedly, as that most destructive of human weaknesses, greed, takes over, that will not always be the case. 

But attempting to regulate the potent risk/reward dynamic out of the equation entirely is unfeasible, and, I would argue, undesirable.

At a recent dinner attended by operational and portfolio management partners from 15 European firms, and hosted by Real Deals and global insurer Marsh, that sense of futility was palpable.

“The notion that you can live in a world without risk is just Alice in Wonderland,” said one. “It is all very well if you live in Strasbourg perhaps, but in reality it simply doesn’t work.”

“Business is inherently risky,” commented another. “If you don’t take any risk then you can’t expect any reward.”

Indeed, the consensus was, perhaps unsurprisingly, that the AIFM is doomed to fail in its bid to unilaterally curb risk. The problem is, as one guest commented, the minute you put a PPM on the table with a risk-adjusted return of above-the-market norm you have, almost by definition, crystallised your responsibility to manage those excesses of risk. 

If you are not clearly defining how you will do that, either the PPM is of no value because it is not based on fundamentals, or you are in breach of your risk management requirements. It is an almost impossible line to tread.

But while the guests were of one voice when it came to their condemnation of the stifling directive, interestingly their approaches to its personal impact were very different.

“If you look at others who have failed over recent years – the FSA, the directors of Farepak, the ratings agencies – what’s happened to them? Nothing. I’m not worried,” said one.

 “I am quite sure I expose myself to more personal risk crossing Piccadilly than anything we are talking about here. It just doesn’t register with me,” said another.

But there were also those who believed that the consequences could be dire.

“People who made perfectly sensible, genuine, and well-documented decisions will be hoisted by the AIFM’s unreasonable expectations,” said a guest who has already crossed swords with the SEC. “Be warned. Bad things will happen to good people.”

And so it would seem that either the AIFM directive will be judged ineffectual and a complete waste of time, or many in the private equity industry will be lynched for failed judgement by those who have displayed very little judgement in the first place. 

It’s anyone’s guess which way it will go. But, as they say, life’s a risky business.