MATCH RISK TIME HORIZONS
No professional football player wants to stick his neck out, or his health, for more than the designated 90 minutes. Some companies are already playing close to their limits in extra time. Investors’ risk time horizons should match the risk scenario.
The sophisticated investor is already aware of these potential cash-flow problems. What is rather more galling is when cash is running dangerously short, despite all prognostications. Companies play out favourable scenarios with dwindling assets or cash. The complication arises from the chain of market players all with different risk time horizons. Everyone wants a cut or return at different times. Because investors have different entry times and various time horizons, it is no longer fitting to state as gospel truth that all long-hold investment decisions are correct. The real risk curve will change along time and market conditions; this can be startling to learn.
It is also important to recognise that the available data and the criteria for judging acceptability may change with time so that what might have been acceptable when a project was initially proposed may no longer be so several years on . . . Thus, the acceptability of the risks associated with a project must be kept under constant review throughout the life of a project.
The real risk curve will differ from the expected risk curve; sometimes, even the most respected pension fund or venerated CEO will fail hugely. An eternal buy-and-hold strategy may no longer be suitable in the modern market. Reputation risk management means that we have to separate deserved prestige from the veneer of respectability and corporate performance. CEO worship is no longer worth the votive candles burnt. The truth may be more along the lines of a real risk curve laid out for the sake of discussion. Unfortunately, the time horizon of a CEO is usually in months and not years – this creates the need to maximise the most that can be wrung out of the firm. Thus, balance sheets can be cosmetically made up for a smoke-screen, not for the benefit of investors.