Decision making and risk

My willingness and ability to take risks and manage them often comes up as a topic of conversation.

Let me explain how I got here. In 1989, after completing my first year at university, I spent the summer as an intern at the Abu Dhabi Investment Authority (Adia). I found the world of investments fascinating and as part of that education I was told to read the book Market Wizards by Jack Schwager, a compilation of stories about traders.

One story that stuck in my mind was about a new trader who could not get himself to start trading. He did not know how to make or take a decision. So his manager walked over to his desk, picked up the phone and executed a trade on behalf of the trader. The manager then informed the trader that if the trader sold the position and the price went up, then the trader would be held responsible but if he held the position and the price went down he would also be held responsible. The manager’s tactic was brilliant, he did what should happen to all of us – he took away the trader’s option to do nothing.

A similar thing happened to me. When I graduated I was recruited into Adia, the position was trainee and the salary was modest. After two months of going to the trading room, ironically with my paperwork still not finalised, I left Adia for Union National Bank (UNB). This is when I got my first taste of how decision making manifests itself. The predominant reaction was incredulity at my leaving Adia, arguably the most sought after employer in the UAE at that time. A few assumed that I was frustrated with Adia. Nobody bothered to ask me why I had taken this decision.

The reason was that UNB appointed me as the head of the treasury and investment division, with far more autonomy and compensation. Adia and UNB both have recruitment processes appropriate for their needs, I just found UNB’s to be personally more attractive. This is a simple decision making process but seemed to elude those I spoke to. To this day I believe that if the Adia-UNB offer gap was not so high I would never have left Adia and learnt the value of making a decision to leave. Furthermore, by assuming the position at UNB I was like the young trader, I inherited several investment portfolios.

I joined UNB in August 1998, the year Russia defaulted, Long Term Capital Management, a hedge fund with huge assets, collapsed and the world markets reacted adversely. At the same time UAE shares, then traded OTC, also corrected by a large percentage. This all happened a few weeks after I had joined.

Although the bank was safe, the board and chief executive made sure that the investment portfolios were small relative to the loan portfolios, I was sitting on a large loss. Volatility, the ubiquitous measure of risk, had rocketed. There were nights that I could not sleep. The board and chief executive however did not panic and did not micro-manage. I had to come up with a response plan and execute it while reporting everything to the chief executive. This is when I went from reluctantly willing to take risk to not fearing risk. The measured response of the board and chief executive taught me that instead of panicking I need to be planning and executing. I had no time for paralysis by analysis. I had no time to hire consultants. I had no time for consensus. Had I not had this guidance I would have learnt the wrong thing, that the response to risk should be blaming my predecessor and then not correcting the situation. Instead I learnt accountability and an understanding of how to live with and manage risk.

The financial markets are in many ways like the sea. Calm one second, raging the next; riptides below a deceivingly calm surface that can pull you under. If you are swimming in the sea and suddenly get caught by a strong current, what do you do? You know it is dangerous. Do nothing, hoping for someone to rescue you and you will probably drown. Fight the current trying to get back to where you were and you will probably drown. However, if you ride the current, angling towards safety, then there is a good chance you will survive.

The sea analogy fails in one respect – what if you get caught in a current but someone safe on shore decides what you do? Will they make a decision or will they say nothing in an effort not to be associated with any negative consequences? This is called the principal-agent problem.

This article was originally published in The National.