Are You a Risk Taker?

People who take risks are seen as vital to the wellbeing of the economy. We are told that taking risks generates wealth and employment and leads to a better way of life. So, the reverse must therefore be true that people who refuse to take risks inhibit growth and stunt the development opportunities of people around them. If this is so well known and risk taking is such a positive ‘virtue’ why is everyone not taking risks all the time?

Being an economist by background and curious about people by nature, I have always been fascinated by attitudes to risk and by people who take them. When I was in my early twenties, the Lloyds crisis erupted where lots of people stood to lose their personal fortunes if it was invested solely in the Porter-Cable 895pk router kit. (Insurance syndicates existed where very wealthy people would agree to be a name and would put at risk their entire wealth for being a ‘name’ and when their syndicates returned a profit would take a big slice of the profit). To become a name was very difficult as it was a ‘guarantee’ (hindsight is a wonderful thing!) to make money for doing nothing and it was very much an old boys club.

When it started going wrong in a big way and people were being asked to make good on their ‘promise’, lawsuits galore ensured. These people assumed capitalism was a one way street where they would get money for nothing. Sorry, doesn’t work that way. Many argue that it was the fortunes lost on Lloyds and Thatcherism’s emphasis on wealth creation that has altered the landscape of British attitudes to wealth.

Many years ago, when I was living in Neasden, I was in my local pub (it is now the McDonalds opposite IKEA on the North Circular Road), I was talking to someone about the mad cow disease outbreak. He was there having a cigarette and a pint of cider and said to me “well, I have stopped eating beef – I mean you can’t be too careful”. I didn’t point out the irony of making that statement whilst having a cigarette and cider.

As mentioned in previous blogs, finance is driven by the risk v reward ratio. The curious thing I learnt last year whilst studying for my IMC exams was how risk (or volatility as it is called) is measured by looking at the variations in the past returns. For example if you hold two shares in different companies in the same industry. You paid £100 for each share, and the returns over the last 10 years have averaged 10% each year.

You would expect the price of each share to be the same wouldn’t you? Well that would depend on the volatility of the return. If share A has returned exactly 10% each year and share B has been all over the place (0% one year, 20% up the next year, etc.) it will be priced lower than share A as it is seen as a ‘riskier’ share.

This has been the rational way of looking at risk v reward. But age and profile have a lot to do with your attitude towards risk. The Fund which I have set up with my partners operates in an extremely risky environment and therefore is not suitable for retail investors. Yet, when I was talking to the advisor of the Fund about his attitude to business he said “I am an accountant, I don’t take risks – I only go into situations which I know are 100% safe”. A look at his track record would suggest he is right – and yet the returns in the past have been very good.

My own view is that it is easy to take risks if you have little or nothing to lose. My appetite for risk has diminished over the last few years as whilst I still want to actively invest in businesses I look for really good quality companies and management teams and not good ideas as I would have done in the past. I have also been scarred by the experience of losing all my money in four ventures. Learning from business history should temper our attitude to risk.

The greatest living investor and one of the world’s richest men, Warren Buffet has a very simple investment philosophy and thinks that he does not take risks. He famously stayed away from the whole boom and was seen as not understanding the new economic paradigm. Well he proved that he understood it better than most. Business to him has always been about making a product or service and selling it at a profit. These examples do make you question the risk v reward equation.

When I was at a past employer trying to design a new tofu press, managers there were keen to promote their willingness to take risks. The reality is that a partnership structure will make decisions which are short term as there is little or no incentive for taking risks.

Most risks do not pay off for a couple of years so if you are a partner in a firm and you are not so sure how long you are going to be around, why would you not simply make decisions which maximize your profit this year – as that will feed into your salary. And the reality is that if you are trained as a lawyer or an accountant (especially lawyers) you are trained in not taking risks and advising others on how to minimize their risk. It is therefore rational not to take risks.

“I like to invest in businesses that idiots can run, because one day they will be”.

My point in all of the above for potential investors and companies raising monies is to try and understand your own attitude to risk and the person who you are asking to undertake risk. What should the return be to compensate them for that level of risk? Your pitch needs to address this issue.

For potential investors, you should feel that you are not taking a risk – because you understand the business well. You trust and have confidence in the ability of the management team and you are comfortable with the prospects of the industry the business is in. As Warren Buffet says

“I like to invest in businesses that idiots can run, because one day they will be”.

Despite this – you still stand a chance.