It is not that the forecaster will always be wrong – he or she may be excellent at their job. It is the lack of acknowledgment for uncertainty that is misleading, the implication that financial market outcomes are as predictable as rolling a die, and that sufficient computational power can produce reliable probabilities when this is simply not the case.
So what can we do as investment managers to mitigate against uncertainty? The first step is admitting that it exists. The second step is trickier, because once we’ve conceded that volatility and standard deviation are not exhaustive measures, we have to distinguish between times when we should use them and times when we should not. This can be a key place for an investment manager to add value, because analysis of non-quantifiable risks is always, by definition, going to be an area for judgement rather than a formula.
Ben Kumar is an investment manager at Seven Investment Management
