Megan Fraser
Reuben Beelders
May 2024
“Comfortably Numb” is a title known to any aficionado of the iconic rock band Pink Floyd. It’s a song whose title alone paints a vivid picture of a feeling of disconnection from reality, the seeking of solace in a state of numbness to escape from the entropy that is life.
The definition of entropy according to Merriam Webster is “the degradation of the matter and energy in the universe to an ultimate state of inert uniformity. Entropy is the general trend of the universe toward death and disorder.” Simply put, the inherent turmoil and challenges that individuals may face.
In his book “Humans Are Underrated: What High Achievers Know That Brilliant Machines Never Will” Geoff Colvin says, “Entropy applies to every part of our lives. It is inescapable, and even if we try to ignore it, the result is a collapse of some sort. Understanding entropy leads to a radical change in the way we see the world. Ignorance of it is responsible for many of our biggest mistakes and failures. We cannot expect anything to stay the way we leave it. To maintain our health, relationships, careers, skills, knowledge, societies, and possessions requires never-ending effort and vigilance. Disorder is not a mistake; it is our default. Order is always artificial and temporary. When we learn to do anything new—how to drive, for example—we go through three stages. The first stage demands a lot of attention as we try out the controls, learn the rules of driving, and so on. In the second stage we begin to coordinate our knowledge, linking movements together and more fluidly combining our actions with our knowledge of the car, the situation, and the rules. In the third stage we drive the car with barely a thought. It’s automatic. And with that our improvement at driving slows dramatically, eventually stopping completely.”
Understanding how risk and entropy work together is like having a compass to help us navigate through life’s uncertainties. On our investment journey through disorder and randomness, risk is the constant companion that we endeavour to recognise, identify, and prepare for. However, as Carl Richards says, risk is what’s left when you think you’ve thought of everything, as illustrated in these stories below:
Risk I (credit to Morgan Housel)
Prior to embarking on space missions via rockets, NASA astronauts ran tests in high-altitude hot-air balloons. On Thursday, 4th May 1961, American astronaut Victor Prather soared to 113,720 feet in one such balloon, nearly grazing the edge of space. The primary objective was to test NASA’s new spacesuit.
The mission proved to be a triumph; the spacesuit delivered on expectations. As Prather descended towards Earth, he cautiously opened the faceplate of his helmet upon reaching breathable altitudes. Despite a smooth ocean landing as planned, there was an unforeseen mishap: Prather lost his grip while securing himself to the rescue helicopter’s line and fell into the sea.
The spacesuit was designed to be both waterproof and buoyant. However, due to Prather’s decision to open the faceplate earlier, he was now vulnerable to the elements. Water poured into the suit, tragically resulting in Prather’s drowning.
Consider the meticulous planning involved in space launches; a myriad of experts meticulously scrutinizes every detail, contemplating numerous scenarios and potential outcomes. Yet, even amidst extensive preparations, unforeseen variables can precipitate catastrophic consequences, underscoring the delicate balance between meticulous planning and the unpredictability of the universe.
Risk II (credit to Robert Sturgeon, Writer of Building Blocks)
“In the early hours of the morning on 11 February 2024, the 50-year-old billionaire and shipping tycoon Angela Chao died in the most unexpected of ways.
Chao graduated magna cum laude in economics from Harvard in 1994 and completed her MBA at Harvard Business School a few years later. After working in banking, she joined the Foremost Group, a global shipping behemoth started by her father, James, in the 1960s. She took over from her father as Chair and CEO of the Foremost Group in 2018. Angela was married to billionaire American venture capitalist Jim Breyer. After the Covid-19 pandemic, they had their first child and moved from Manhattan to Texas, where they owned a 900-acre ranch.
On the evening of 10 February, Chao had a fun dinner and celebrated Chinese New Year with friends at the guest lodge on the ranch. When festivities wrapped up just before midnight, Chao decided to hop into her Tesla and take the short drive back to the main house. Leaving the lodge’s parking area, she made a mistake and reversed her car into a deep pond next to the lodge. Trapped inside the sinking vehicle, she drowned.
Before her death, Chao had more going for her than almost anyone on the planet – mother, wife, CEO, Harvard graduate, ultra-rich and connected. If you asked her on 9 February to list literally a million things that were on her mind and worrying her, driving her Tesla into a pond wouldn’t have made the list.”
Why does risk matter? Risk matters when investing because it directly relates to the possibility of losing money. When you invest, there’s always a chance that the value of your investments could decrease due to various factors such as market volatility, economic downturns, or unexpected events. When considering investment risk, simplistically there are four factors that should be considered, namely volatility, liquidity, inflation, and security.
Volatility measures the degree of variation in the price of an asset over time and is commonly and loosely used as the proxy for risk. High volatility means that prices can swing widely, which can lead to both higher potential returns and higher potential losses. Investors who can tolerate and potentially capitalise on this variability may be willing to accept higher levels of risk, while those who prefer more stability would typically prefer investments with lower volatility.
Liquidity refers to how easily an asset can be converted into cash without significantly affecting its price. Highly liquid assets, like stocks traded on major stock exchanges, can be bought or sold quickly with minimal impact on their market value. In contrast, less liquid assets, such as certain types of real estate or private investments, may take longer to sell or require finding a buyer willing to pay a fair price. Ensuring that a portion of one’s portfolio remains in liquid assets provides flexibility and access to funds when needed.
Inflation erodes the purchasing power of money over time, meaning that the same amount of money buys fewer goods and services in the future than it does today. When investing, it’s important to take inflation into account to ensure that the returns earned outpace the rate of inflation. Investments with returns that consistently exceed the inflation rate help to preserve and potentially grow the real value of an investor’s wealth over time. This is particularly relevant in a country with a high inflation rate, such as South Africa.
Security, in the context of investment, refers to the assurance of return of capital over return on capital. Generally, investments with lower risk, such as government bonds or high-quality corporate bonds, offer greater security because they are less likely to experience significant declines in value. On the other hand, investments with higher potential returns, such as stocks or real estate, often come with higher risk levels and may not guarantee the return of the invested capital.
Each of these factors should be taken into consideration in order for investors to make informed decisions about risk management, balancing the potential returns of investments with their associated risks and ensuring alignment with their financial goals and risk tolerance.
Looking at the process of entropy, we can identify phases of order, disorder and reorder. When making investment decisions, we presume an environment of order, a level of understanding with a spectrum of risks recognised and, to some extent, understood. In such a world, below is an illustration of what could reasonably be considered a practical approach:
However, one cannot only plan for order. In the words of Mike Tyson, “Everyone has a plan, until they get punched in the mouth!”
Any investor that spends any length of time in the market is likely to be taken unawares at some point; equities, property, bonds and cash all have risk attached – what is important is to recognise and manage these risks. Any suggestion of risk-free investing should be met with scepticism – just as with fat-free or sugar-free offerings, there is always a consequence, even if it’s not on the label or immediately apparent.
In a state of disorder, liquid is no longer liquid, secure is no longer secure. The responsible approach is twofold; to recognise the impact of emotion in this situation, and to have an accessible, implementable plan. In his book, The Checklist Manifesto, Atul Gawande proposes the use of checklists as a way to keep order, ensure that key tasks are performed and help manage complexity and reduce errors. This is an accurate portrayal of Gryphon’s rules-based investment philosophy.
Secondly, embracing the possibility of disorder allows us to make the necessary preparation. We all recognise this statement: “Ladies and gentlemen, in the unlikely event of a loss of cabin pressure, oxygen masks will drop from the overhead compartments. Please remain seated and pull the mask firmly towards you to start the flow of oxygen. Place the mask over your nose and mouth and secure it with the elastic band. Please ensure to put your own mask on before assisting others.” While we may roll our eyes and look anxiously for the snack trolley, at the very least, this situation is unlikely to punch us in the mouth.
Joe Simpson is a renowned British mountaineer and author of a fascinating book called Touching the Void about his harrowing experience in the Peruvian Andes in 1985.
While no one would venture out onto a glacier without being properly prepared, nature has a way of punching even the most experienced adventurers in the mouth. Joe Simpson and his climbing partner, Simon Yates, embarked on an ambitious expedition to climb the Siula Grande.
Their ascent went smoothly until disaster struck. While descending a treacherous ice slope, Joe slipped and fell over the edge of a crevasse, plummeting into its icy depths. In a desperate attempt to ensure his own survival, Yates was forced to cut the rope connecting them, ostensibly leaving Joe for dead. Miraculously, Joe survived the fall but with very severe injuries, including a broken leg. Stranded alone in the crevasse, with no hope of rescue, Joe faced a grim reality. Understanding the breadth of his situation and his options, with sheer determination he devised a plan to crawl and drag himself out of the crevasse and back to their base camp. For three agonizing days, Joe battled excruciating pain, exhaustion, and the relentless elements as he crawled inch by agonizing inch across the icy wilderness. Meanwhile, Simon waited anxiously at the base camp, unaware of Joe’s fate and growing increasingly desperate. With no sign of his partner and dwindling supplies, also understanding the breadth of the situation and his own options, Simon faced an impossible decision: to stay and wait for Joe, risking his own life, or to continue the descent alone.
Literally just as Simon was preparing to leave, exhausted and defeated, he spotted a figure in the distance. To his disbelief and relief, it was Joe, crawling towards the camp against all odds. Despite his injuries and the harrowing ordeal he had endured, Joe had somehow managed to defy death and return to safety.
Mountaineering serves as a compelling lens that underscores the critical significance of being prepared for unforeseen circumstances. Climbers must remain flexible, constantly assessing risks and adapting plans to changing conditions. Contingency planning is essential, with climbers having backup strategies for emergencies, route alternatives, or delays. Self-reliance is crucial, as climbers must be prepared to handle emergencies independently in remote environments.
Coming back to investment risk and being as prepared as possible, a punch in the mouth will catch any investor off-guard. The process of order, disorder, and reorder is inherent in the cyclical nature of markets. While meticulous preparation is paramount, investors must guard against complacency, avoiding the presumption that all contingencies are accounted for. Emotions often prove detrimental to wealth management, underscoring the need for an open-minded and vigilant approach to investment decision-making.
“Everyone has a plan, until they get punched in the mouth!”
Mike Tyson
