Just as the season has turned to summer, it feels as though our world is turning over a new leaf as well. More than 35 million doses of COVID-19 vaccines are being administered per day, several cities have effectively ‘re-opened’ their economies, global GDP growth expectations are being revised upward, and the Olympics may finally take place. Seeing the world’s major stock market indices at record highs, investors too may be saying “let the games begin.”
As the world kicks-off what feels like a new cycle of growth, the market may hesitate to sprint too far ahead with a list of concerns trailing behind. As investors, it is our duty to understand risks in the marketplace and attempt to factor them into our return expectations. To begin, one may only need to use their imagination to compile a list of the risks present. Doing so with any precision has proven to be a challenging task. Only eighteen months ago, very few of us imagined a coronavirus pandemic would make the world stand still. The economic calamity which followed was beyond imagination, it would have seemed.
The COVID-19 crisis delivered investors a lesson about the perils of the ‘unknown unknowns’. This term was coined by American psychologists Joseph Luft and Harrington Ingham in the 1950s, with one of its most notable mentions made by former US Secretary of Defense Donald Rumsfeld. In February 2002, Rumsfeld explained the difficulty in making decisions to confront risks:
“Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.” – Donald Rumsfeld
Though Rumsfeld was ridiculed by some following this statement, partly because it seemed to be full of philosophical jargon, it was a concise illustration of the difficulty to analyze risks. Investors should understand well what was meant by Rumsfeld, especially in the context of the hard and fast economic consequences brought by the COVID-19 pandemic. Further, hindsight today allows us to recognize what would have been the consequences of not staying invested through the market’s expeditious recovery – the timing of which was the crucial ‘known unknown’ just over a year ago.
It is difficult to pin down whether the economic toll of the virus was a true unknown unknown. Pandemics have taken place at least twice within the last two decades and COVID-19 was gaining the world’s attention through January and February 2020. Regardless of where the risk would have fit within the Johari Window (below), investors have been served an important lesson about updating expectations using new information and applying learnings from the past.
Source: Luft J. and Ingham H. (1955), & QV Investors
Though I am a new addition to QV Investors, each day I have observed or participated in discussions which attempt to identify and understand the risks present in our investments. This involves asking questions such as where an investment thesis could be wrong, how a firm’s competitive environment could change, what the downside could be and what assumptions were used to estimate it. Formally, QV’s risk management review requires a structured evaluation of valuation, growth, and risk metrics at the portfolio level on a monthly basis. This routine audit reduces the chances of deviating from our investment process.
Raising questions can help us see through our blind spots. Transferring knowledge from our own past experiences to the rest can reduce the likelihood of being blindsided in the future. As generalist investors, persistently exploring new ideas while keeping abreast of changes in the economy can increase the odds that we’ll avoid the perils of the unknown unknowns.