The precautionary principle

There’s not a parade I won’t rain on.  That’s my usual elevator pitch; may as well lead with the bad news.  It is not at all an unfamiliar concept: Watch the downside and the upside takes care of itself, echoed (but not originated) by a bumptious former president.

It’s not great for our popularity in times of bullish expectations.  People get the sense that we advocate against investment/growth plans that are obviously offer sure payoff and low risk.  We are seen to steer them away from the sure thing right now for fear of a hypothetical event that might happen someday.

Full disclosure: we sometimes do urge people to avoid expansions that depend on growth rates, cost of funds, cost of product assets, that are historical outliers and that put the entire business, not just the discrete project, under threat should they be wrong.  We point out when expansions, rather than improving financial performance (except in the narrow sense of how big the bottom line is), hurt return on assets and compromise liquidity.

But the real story is, we’re fans of innovation and entrepreneurship and think that best lest to the person leading the firm, often as not the founder, or perhaps a generation or two down the line from the founder.  We want to clear the deck of obstacles and risks so they can practice their craft. 

Trends and general enthusiasm tend to be just such obstacles, insofar as they’re symptoms of low-interest-high-asset epochs that just now we might finally be finding the tail end of.  They tend to trade innovation for crowd-following and tempt limited financial resources away from the founder’s vision and into low-return diversions.

Low returns are sometimes a hallmark of low risks, but business cycles are funny.  Sometimes they’re a symptom of high risks.

Like right now.  We marvel at various hard asset categories where investors fall over each other to buy assets where the best-case scenario cap rates are less than 5%.  That is less than than interest rates (and until recently, inflation as CPI measures it), but those rates remain, despite recent increases, at historic lowest-quartile levels.

Many have locked in a rate of payout that will in time be eclipsed, by orders of magnitude, by other opportunities and by inflation.  Even if the investment delivers as promised without hiccup, how do you feel about being locked in at 5% if CDs bump to 14%?  Yes, that was the 80s, but what has happened, can happen again. 

And what if you need to liquidate (e.g., lock in a massive loss) for unrelated reasons, or if the investment itself falls prey to changing economic times?

I’m content to rain on that parade, which is more like a funeral procession.  The thing is, the whole event is entirely optional for both mourners and deceased.

This is why we look into the abyss.  It looks back, or feels like it, but also, you don’t step or fall headlong into it.