Afraid of flying?
Learning to trust ‘747 investments.’
There are investment products that are easy to understand, but hard to execute, such as mortgage funds (since running a mortgage book requires significant experience and expertise in the space), but there are also much more complex funds that generally involve high volumes of trading, a lot of math, and the use of leverage, shorting and derivatives to enhance returns and manage risk.
Developing a comfort level with one of these funds, which often trade in multiple geographies and a variety of types of securities, has a lot more to do with understanding the track record of those who built it, operate it and maintain it rather than the actual trading strategy. We call these “747 investments,” because investing in them is very similar to stepping into a 747 jumbo jet to fly to Europe.
Chances are you have zero understanding of what is going on in the cockpit of a 747. Even if you were to understand all of the hundreds of instruments, you would still be clueless as to how to actually fly the plane. And in the “unlikely event of an emergency over water,” you would be powerless about what steps to take to save the lives of the passengers on board.
Yet you still walk down the gangway, show your boarding pass, take your seat, put on those comfy slipperettes, pick a movie and enjoy the trip. What makes you so confident that you will safely get to your destination? It comes down to trusting that a lot of people with very important jobs have done them correctly before and after takeoff, from planning and design to testing and inspections to training the crew and airport personnel.
There is also a near-perfect alignment between your interests and those of the pilots; they are “all in” right alongside you in getting from point A to B without incident. If you’re safe, they’re safe. This is a good example of someone else’s self-interest working to your benefit.
A complex investment fund, likewise, requires a lot of people to do their jobs correctly. During the due diligence phase, investors attempt to find an investment fund that has a well-designed strategy, is well tested and well executed by professionals who have long and positive track records.
The fund should be operated within a regulatory regime designed to significantly reduce the likelihood of malfeasance, and has triggers in place to set off alarms in the event that human error occurs. On a regular basis, independent third parties perform a battery of tests to ensure the fund does what its creators and operators say it does.
And, in the case of the best funds, the investment fund managers are properly aligned with their investors. This usually takes the form of managers having a significant part of their net worth invested alongside their clients in the fund. If you crash, they crash.
People who are afraid of flying are said to have a phobia, which is classified as an irrational fear. Since the chance of dying in a plane crash is infinitesimally small when compared to, say, driving, avoiding flying comes down to raw fear or an ignorance of the facts.
In investing, there are those who are unwilling or unable to learn the details about complex investment funds. For those people, not investing in such funds isn’t a phobia at all, but quite rational. Since they don’t have a good handle on what risks there are and how they are managed, they shouldn’t get on board.
By the same token, however, to completely avoid complex investments simply because they are complex is as irrational as never flying at all just because some planes crash.
If you have the ability to do some due diligence yourself, or to find an advisor knowledgeable enough to provide you with adequate research on a complex investment, you should consider having it in your portfolio.
Simply taking a pass on these investments could very well result in missing out on a safe, smooth flight that gets you safely to your destination time after time.