Recently, I was hiking with my family in the mountains a couple of hours west of Denver. During the hike, we were crossing a stream, and in my attempt to help my daughter across, I slipped and came down hard on a pile of rocks. Upon inspection, it was only a surface-level injury and something that I could easily patch up with my first-aid kit — which was in my car about five miles away. I was prepared (I had thought to purchase a first-aid kit), but I had failed to actually put the kit in my backpack. Preparation without full implementation isn't particularly useful.
Of course, leaving my first-aid kit behind wasn't simply an oversight. It was likely a semi-conscious decision resulting from overconfidence, coupled perhaps with a lack of imagination. I've gone on more than 100 hikes in the mountains and I "never" get hurt, so ensuring my first-aid kit was in my pack wasn't front of mind.
And therein lies the point. When nothing bad has happened in recent memory, we get lulled into a false sense of security. Risk management is boring until it's not; just ask any security guard or TSA official. And risk management isn't simply judging the probability of a loss, but also the magnitude of a loss should one occur.
Six and a half years have now passed since the stock market bottomed out during the financial crisis. U.S. equities have annualized at between 17.5% for the largest companies (based on the Russell Top 200 Index) and 20.9% for mid-sized companies (based on the Russell Mid-Cap Index), with micro-cap and small-cap stocks falling in between. These outsized gains, along with our temporal distance from the pain felt during the crisis, have made it increasingly difficult to stay invested in risk-mitigating strategies.
Consider for a moment the flows to liquid alternatives over the past year.
