For the first time in 60 years, Peter’s football team was in a grand final. What’s more, its opponent was one they had beaten earlier in the season. But then, disaster! The star full forward pulled a hamstring at training and was out of the game. Peter was inconsolable.
Welcome to the world of key person risk. The success of Peter’s favourite team was largely built around this once-in-a-generation player – a man of freakish and almost irreplaceable talents whose contribution to the team’s success was so significant that his absence was catastrophic.
Key person risk is a common theme also in business. In Silicon Valley, a company called Theranos promised to revolutionise healthcare with technology for diagnosing diseases with just a few drops of blood. Selling the company was a charismatic young woman whose “serene blue eyes and Mona Lisa smile” charmed business and media backers who wanted to believe in miracles. That woman, Elizabeth Holmes, now faces up to 20 years in jail for fraud.
Even the most conservative businesses are subject to key person risk. Legendary investment company Berkshire Hathaway, which has built a business worth more than $600 billion over yearly six decades, has been largely dependent on stock-picking Svengalis and now octogenarians Warren Buffet and Charlie Munger. But in the past decade, Berkshire has lagged the market, with Buffet slow to sniff the wind about the shift to ESG investing and not alert to the huge impact of climate change on Berkshire’s insurance business.
It seems halos, however glittering, inevitably rust. Here in Australia, star fund manager Hamish Douglass of Magellan Financial Group was for years a regular feature on the business pages, inevitably dressed in his favourite cowboy boots to spruik his stock picks and forecasts.
Once touted as Australia’s Warren Buffet, Douglass got it right for so long that few people imagined he could ever be wrong. In 2020/21, however, Magellan’s flagship global equities fund underperformed the market by nearly 17 percentage points. Things got worse from there, with Magellan’s CEO quitting in December and the company losing its biggest institutional client.
As in football or business, pinning one’s hopes on the acumen or charm of a single individual, however attractive they might seem, is a risky proposition. What if their skills (or luck) suddenly desert them? What if they fail to spot a fundamental change in their field of endeavour? What if they simply want a change in occupation and leave it all behind?
Luckily, there is an alternative to punting it all on a star. In football, that might mean backing a side with sound management, a strong culture that drives champion teams rather than teams of champions and a well-funded talent spotting program that grooms future stars.
In investment, it comes down to ensuring that whoever manages your money has a clear and accessible investment philosophy that they stick to; evidence-based, scientifically-grounded portfolio design; and a process-driven, rules-based application that is not dependent on the whims or opinions of any one individual.
This way, you are reducing the idiosyncratic risks you can’t control, like being dependent on a single individual. You are boosting the transparency, reliability and efficiency of outcomes. And you are ensuring you are getting what you pay for.
When it comes to investment, your future shouldn’t be written in the stars.
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