Jul 8

Does Your Investment Process Have a Grand Strategy?


Before you say ‘of course’ or ‘yes’ to that question, you might want to take a closer look. Let’s start by taking…

A Trip Down TSA Lane

A gentleman approaches the TSA security line at a local airport. He places a very cold bottle of water in one of the bins ready to go through the TSA’s X-ray machine.

“Wait a second,� the TSA officer barks, “you cannot take that bottle of liquid through security. The rules say you cannot take more than 3 ounces of liquids in any container.�

“I know that,� the gentleman quietly acknowledges, “but this bottle is about full with ice.�

Realizing his duty to maintain airline safety, the TSA officer opens the bottle and notes, “Yes, it is mostly ice, but I see there is some water in there.� He gives the bottle back to the gentleman, who promptly drinks the water and replaces the cap.

“It is all ice now, OK?�

Carefully examining the bottle, the TSA officer frowns a bit and says, “OK, just put it through the machine with the rest of your items.�

Amazingly, this is a true story. Please do not try this at your local airport, but it does point out another flaw in the government’s “Grand Strategy� for keeping the flying public safe.  Melted ice (water) can be dangerous, but more than 3 ounces of un-melted ice is not. Huh?

Although, each of us may have our own TSA related story, the point of this story is to show how a flawed strategy can produce ridiculous results.

Grand Strategy and Your Insurer

At Insurercio.com, our headline article is from venerable investor Charles Ellis. Lessons on Grand Strategy Applied to Investing considers the process of investing in light of the lessons learned from some of history’s great minds of Grand Strategy. It is a terrific read as it applies history’s strategic lessons to investing.

But, what of your insurer’s investment process?

Does it have a Grand Strategy? (And, ‘get the best yield/best return’ is not a Grand Strategy, but just one of many worth investment goals and objectives.)

How do you tie together all aspects of the Investment Process Value Chain into what your company is trying to accomplish? And what strategies will be implemented in order to accomplish that? How do those strategies, then, tie to your company’s overall key goals and objectives?

For example, let’s take one very important link in the Investment Process Value Chain: asset allocation. There are plenty of models out there that will suggest an asset allocation. The models will be of varying levels of complexity.

But, what are the underlying strategic assumptions in those asset allocation models? Do they assume a certain amount of liquidity of the asset classes being modeled? Is that amount of liquidity appropriate?

To what extent will the model be wrong in its assumptions of return and risk? Every model will be wrong. It’s just a matter of degree.

And, most importantly, have multiple models (or, ways of looking at asset allocation) been considered?

Warren Buffet’s ‘partner’ at Berkshire Hathaway, Charlie Munger, may have said it best:

“The first rule is that you’ve got to have multiple models because if you just have one or two that you’re using, the nature of human psychology is such that you’ll torture reality so that it fits your models, or at least you’ll think it does…â€�

Charles Ellis’ article is highly recommended for looking at investing from a more generic (not insurance company specific) approach to developing a Grand Strategy. Meanwhile, our continuing goal is to develop and apply a successful Grand Strategy for an insurers’ investment process and that includes considering many different approaches.