Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
The real value of an outrageous prediction
Saxo Bank’s annual “Outrageous Predictions” are rarely correct, but they’re correct more often than is really comfortable. In 2015, their analysts predicted that the United Kingdom would vote to leave the EU (right, but early); in 2017, they predicted huge gains for Bitcoin due to the macroeconomic policies of the Trump Administration (right, but due to speculation instead); and in early 2022 they predicted that climate targets would get kicked down the road as policymakers tried to fight inflation (right again, but mostly due to Russia’s invasion of Ukraine).
The new slate of predictions seems somewhat less outrageous than usual. In fact, the first – which comes courtesy of head of equity strategy Peter Garnry (photo at top), and holds that billionaires will band together to create a “Manhattan Project” for climate change technology – is downright probable, given that the Twiggy Forrests and Andrew Carnegies of the world have positioned themselves as the answer to global climate change.
Your mileage might vary on other predictions: that Emmanuel Macron will resign the French presidency, that widespread price controls will be introduced to cap official inflation, or that a ban on tax havens will kill private equity (never happen, given how many politicians personally depend on them).
Outrageous predictions are all the rage right now. Anybody who’s spent any amount of time talking to fund managers in the last nine months will have heard how wary they’ve grown of “Risk X”: Rumsfeld’s “unknown unknowns”, Ian M. Banks’ “Outside Context Problem”, or Taleb’s (in)famous “Black Swan”.
Taleb’s characteristics of Black Swans are as follows: “First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme ‘impact’. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.”
But Black Swans rarely occur; events that are deemed Black Swans are usually actually “Grey Swans”, though these exist outside Taleb’s taxonomy. To borrow from Investopedia, Grey Swans are “a potentially very significant event whose possible occurrence may be predicted beforehand but whose probability is considered small”.
Many a Grey Swan has alighted in the pond this year. Putin’s decision to invade Ukraine – despite a chorus of foreign policy boffins, politicians, economists, and fund managers saying that he’d be mad to do it – caused a reassessment of how rational geopolitics really is. The near meltdown in the UK pension system saw the commonplace practice of liability-driven investing scrutinized by the Financial Conduct Authority.
Indeed, it’s this latter issue that many fund managers now fear: that, like some foolhardy archaeologist releasing an ancient curse from a sealed tomb, shoddy economic policy or the pace of rate hikes or will cause dysfunction in some unexamined part of the financial system – dysfunction that will spread throughout the whole system, roiling markets and economies alike. It’s the quintessential Grey Swan
event; predictable, but unlikely to happen, with devastating consequences if it does.
None of the Saxo predictions are Black Swans (having been spoken into existence, they no longer count), though they are deeply grey. And Grey Swans are likely to occur with increased frequency as the macroeconomic and monetary regime changes, the money-fueled tech bubble deflates, and geopolitical tensions flare.
So the value of an ‘outrageous’ prediction is just that. In 2021-2022, outrageous events have become commonplace. And while it remains to be seen whether the EU establishes its own armed forces or the UK decides to hold an “UnBrexit” referendum, predictions like these give investors the opportunity to stress test their own powers of foresight, which are rarely as robust as claimed. It helps to imagine the almost unimaginable. After all, what Saxo’s ‘correct’ predictions show is that the future is rarely settled; that most forecasts are written in sand, and that it pays to be prepared for anything.
