MarketFox Investment Commentary – Investment Innovation Institute

MarketFox Investment Commentary

Survival = Risk Management

Regret Management is not Risk Management

One of the best examples of real-world risk management that I’ve ever seen was on an episode of Man vs Wild featuring Bear Grylls. Well, not exactly real-world as the show features staged survival scenarios. There’s a camera crew and rescue is an option if things go wrong. Still, it offers some important lessons.

In this particular episode (season 2, episode 5), Grylls was stranded by the shore of a lake in Patagonia, Argentina. Patagonia is a wild and inhospitable place, especially in winter. Grylls needed to get to the other side of the lake to find his way to safety.

A recurring theme in Man vs Wild is that time is critical in survival situations. The longer you’re stranded in the wilderness, the worse your chances of survival or rescue become.

Walking around the lake would take several days. This was time and effort that a cold, tired and hungry Grylls couldn’t afford. The quickest way to get to the other side was to swim across the lake. But the water temperature in the lake was ice-cold. Grylls would almost certainly succumb to hypothermia and drown.

Any opportunity to save time can be the difference between life or death.  It was worth trying to find a way to cross the lake if there was a way to manage the risk of hypothermia. Grylls decided to make a raft using tree branches collected from the banks of the lake. A raft would give him the chance to cross the lake without getting wet.

It’s hard to make a sturdy raft without the right tools and materials. Grylls knew that his flimsy raft could fail. And if failure happened, it was likely to come out in the middle of the lake, i.e. at the furthest possible point from safety.

If the raft failed, Grylls would have to swim for the shore. He would be frozen cold by the time he got there. The only way to prevent death from hypothermia would be to get warm as quickly as possible.

Grylls decided to light an enormous bonfire on the shores of the lake before boarding his raft. That way, if the raft fails, he can swim to the shore, strip of his wet clothes and warm himself by the fire.

What happened? The raft gradually sunk lower into lake until Grylls was forced to abandon it and swim back to the shore. Once there, he removed his wet clothes and warmed himself beside the raging bonfire. Unable to cross the lake, Grylls took the long way around and walked.

What lessons are there for investors?

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There are a lot of risks that diversification can’t protect investors from. Diversification relies on a set correlation, risk and return assumptions. These assumptions are notoriously unstable, particularly in a crisis.

There was no risk-free course of action available to Grylls. He had to choose between exposure to the elements and hypothermia. As Corey Hoffstein, Chief Investment Officer of Newfound Research reminds us, “risk cannot be destroyed, it can only be transformed”.

Investors often find themselves in a similar situation. If they hold cash, they run the risk that they’ll lose purchasing power due to the effects of inflation. Bonds carry shortfall risk as low current yields are unlikely to meet future income needs. Equities can reduce inflation and shortfall risks but this comes at the expense of increased volatility and sequencing risk. Unlisted assets promise reduced volatility (it’s debateable whether or not this is anything more than an optical illusion) in exchange for illiquidity and higher costs. 

It’s dangerous to focus too much on obvious risks while at the same time underestimating less obvious risks.

It would have been easy for Grylls to have decided to simply walk around the lake.  Drowning due to hypothermia is obviously an unacceptable risk. But Grylls understood that an extra two or three days exposed to the elements, in sub-zero temperatures, with no food or clean drinking water was just as dangerous.

Most of us would rather choose slow and debilitating death from an error of omission; rather than a quick and painful end due to an error of commission. We do this to minimise regret.

Investors are also at risk of focusing too much on near-term, salient risks instead of long term, less-obvious risks. The classic example of this is overemphasis on volatility compared to other risks such as the erosion of purchasing power due to inflation.

As a general rule, the emphasis on minimising regret increases as more people are involved in a decision-making process.

Taking unacceptable risks can be appropriate if you use a risk management strategy. Grylls felt comfortable attempting a lake crossing because he had a risk management strategy in place.

Investors construct portfolios full of ‘unacceptable’ risks. Taking these risks is appropriate, provided there’s a risk management strategy in place. Diversification, hedging and stop losses are examples of risk management in practice. Dynamic asset allocation and trend following can also be used to manage risk.

Don’t to rely on a single risk management strategy. Grylls used two risk management strategies, a raft AND a bonfire. Most investors rely on diversification as their primary risk management strategy. There are a lot of risks that diversification can’t protect investors from. Diversification relies on a set correlation, risk and return assumptions. These assumptions are notoriously unstable, particularly in a crisis.

Some risks need to be hedged (i.e. by using derivatives). Others should be avoided when the risk /return trade-off is unfavourable (i.e. dynamic asset allocation).

Use risk management to create asymmetric payoffs. Grylls cleverly used risk management to preserve all of the upside while dramatically reducing the downside. In so doing, he created an asymmetric risk/return payoff. Compare the two scenarios:

Scenario #1 – Lake crossing, no risk management:

  • Best case outcome – Increased chance of survival
  • Worst case outcome – Death from hypothermia and drowning

Scenario #2 – Lake crossing, with risk management:

  • Best case outcome – Increased chance of survival
  • Worst case outcome – Two-to-three days extra in the wilderness


You’re more likely to use risk management when you have skin in the game. This point is so obvious it almost goes without saying. But it’s still important to highlight as the investment world is full of agents that have very little skin in the game and, therefore, no direct incentive to manage risk.

Focus on decisions, not outcomes. Grylls’ raft failed and he ended up having to walk in the cold anyway. Does that mean he made the wrong decision? No, he took a calculated risk to dramatically increase his chances of survival by reducing the time he would be exposed to the harsh elements.

Investor are constantly tempted to judge the quality of their decisions by their outcomes. This is often a mistake due to the large role that luck plays in investing.

And while its true that Grylls’ raft failed; his risk management strategy was a total success.

Life involves taking risks. Sometimes the right thing to do is to avoid them completely. Unfortunately, that’s not possible in investing. There’s no genuine risk-free choice[1]. We must learn to confront risk.

A sound risk management strategy can make all of the difference when it comes to survival. So how do you manage risk?

[1] Unless you can afford to purchase enough inflation-linked government bonds to give you the income that you need. Even this theoretically risk-free portfolio carries potential opportunity cost.


[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.