The role of the Chief Investment Officer (CIO) by Dr. Ken Choi > 경제예측 돈의흐름

The role of the Chief Investment Officer (CIO):namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

The two cardinal rules of investment according to the legendary investor Warren Buffet are: First, do not lose money; second, do not forget the first rule. These seemingly light-hearted rules, I believe, highlight the most important element in investment fund management: risk management. That is, the job of the CIO is to ensure that your fund is invested in sound assets.

(1) Investment Risk and Risk Management.

            You may raise the fundamental question: “What is the investment risk?” The investment risk, to me, is the possibility that the future cash inflow from an asset purchased may fall short of the price paid today for the asset. (Notice that I do not use the usual jargons: standard deviation, etc) You may then ask “how do you manage the investment risk?” The best way to manage the risk, I believe, is having a “margin of safety” when one estimates the future cash inflows from the asset vis-à-vis the price of the asset. (Notice that I do not recite the usual mumbo jumbo: diversification of portfolio, portfolio value at risk, etc) It follows that avoiding certain assets with insufficient margins of safety is a conservative approach, although buying such assets may be at times a conventional practice. (i.e., Refraining from smoking is good for your health, albeit smoking is popular among certain people.)

A case in point is the so-called ‘private equity’ funds. The ‘private equity’ is, I think, a euphemism for ‘leveraged financial flips’. These ‘leveraged flips’ are inherently risky and highly illiquid; worse yet, they engage in socially disruptive practices while charging exorbitant management fees to their investors. Any prudent CIO ought to shun the ‘private equity’ operators. Yet, many public pension funds in drove have been lured into a proverbial coin-toss where tails, they lose; heads, the private equity operators win.

Commercial real estate is another example. Commercial real estate market is risky, cyclical and highly illiquid; further, the management fees are very high. Suffice it to say that Warren Buffet has never, throughout his long career, invested in real estates.

(2) Asset Manager Selection and Management Fees:

            As you know, within a particular asset class, say U.S. equity, there are many specialists, both active and passive (or index-fund) managers. Clearly, a judicious selection of right managers is a key to investment successes. You may ask “how do you identify ex-ante an ex-post successful manager?”  People commonly rely upon the past performances of the managers to infer the likelihood of future successes. The shortfall with this approach is that the past performance of a manager might be the reflection of his luck as much as her skills. (The sample size is often just too small to tell.)

Moreover, a majority of active managers fall below the market average (i.e., the performance of index fund) net of their management fees in the short run; in the long run, say over a five-year period, most of active managers under-perform the index. The implication is clear: unless the active manager can provide a convincing economic rational for superior performance, you ought to prefer index funds over active managers because index fund managers cost much less and yet deliver more than active managers.

Investment is not about trading financial securities, but is about buying underlying cash-flows or businesses. Only if a fund manager has a good approach to identifying sound businesses, (s)he might have a chance to outperform the market. (Note that seemingly sophisticated trading methods are mostly fool’s errands because of their defective reasoning and high transactions costs. For instance, quantitative approaches relying on a statistical analysis of financial data commonly make a fatally flawed assumption that historical data are a sample from a certain underlying probability density function.)

(3) Asset Allocation and the Value of the CIO:

            As you know, the overall success of an investment fund depends more on the purchase of right asset classes than the selection of right assets within a given asset class. (i.e., the weight on the asset class is usually greater than the weight on a particular asset.)  Hence, the value that the CIO adds to your investment fund would depend more on how well the CIO allocates the fund among various asset classes spanning the globe (i.e., strategic asset allocation) than on how well the CIO attempts to identify superior securities or fund managers within an asset class (i.e., tactical asset allocation). You may now ask “how do you allocate investment fund to various asset classes?”

            I have developed the “Oscillating Risk Premium Hypothesis” which says that the risk premium associated with a particular asset class does not always commensurate with the risk involved, and that when the risk premium is unsustainably low or high, the market price will change, often precipitously, to correct the excesses. This hypothesis provides an analytical framework for optimizing a dynamic allocation of your investment fund over various asset classes. (The risk premium is a manifestation of prevailing market biases. The human greed pushes the premium down toward nothing while the human fear can drive it up in panic. I monitor the risk premium and anticipate changes.)    

(4) Solvency in Retirement:

            Ensuring the solvency of your finance in retirement would become a paramount task as you get older. Your CIO ought to make investment decisions based on careful sifting of economic evidence and concentrate doggedly on maximizing your investment fund.