Those of you who read my last blog and have returned (thank you for making an old man very happy, btw) will know that it was poorly disguised rant about the problems that acronyms and abbreviations can create. In my naiveté, I wrongly assumed that this would be a cathartic experience which would allow me to relax whenever I saw an acronym in future. The therapy hasn't worked. All it has done is make me think more deeply about the acronyms which wind me up most. I will leave SMART objectives and VaR for a later blog and today focus on the KISS principle. For those of you who are blissfully unaware of the principle, KISS stands for "Keep it simple, stupid" which was apparently first coined around 1960. Now, the intolerant side of me objects to being labelled stupid but I do accept that the first three letters represent a legitimate challenge to our industry which tends to come up with new asset classes every six months in the name of innovation. However, the implicit appeal of the acronym gives more weight to an attribute ('simplicity') than it should. In this case we manipulate ourselves. To illustrate my point I will share a memory with you:
My first soft top was a Triumph Spitfire. Even though I am a long way from being a mechanical engineer, I could open up the bonnet (if the handle didn't fall off) and see an engine where it was possible, even for me, to identify just about every component. I loved that car but the local garage loved it more because it kept on breaking down. Now, I have a soft top SAAB where I open up the bonnet and can't identify any component. I'm not sure if I love my SAAB as much but I have had the car for ten years and it has only broken down once. I vote for complexity but, crucially, the reason I vote for complexity is that I am being rewarded for it.
So it is for investment, over the same period of time, portfolios have gone from being a simple mix of gilts, domestic equity and a little bit of property to a smorgasbord of often impenetrable asset classes. But just because we have made it complex, it doesn't mean that we have been rewarded for that complexity. Indeed, I have seen some research that suggests our industry has done the opposite. Although this study was more directed at the less good timing of the introduction of the extra layer of complexity rather than being critical of the complexity itself – right thing, wrong time seems to be the conclusion.
So the challenge remains – are we being sufficiently rewarded for the complexity we have introduced or have we indeed been stupid by not keeping it simple? Certainly, in isolation, complex asset allocation strategies introduce risks associated with the lack of transparency and the extra cost, to name but two.
To move away from the KISS portfolio we must first challenge more rigorously what benefit the complexity brings and whether the same result can be achieved more simply. Too often complexity is introduced and justified by diversification. Too infrequently is the actual need/benefit from that diversification challenged. Just as we challenge investment managers for over-diversification at the stock level, so the investor should challenge himself/herself and his/her advisers at the asset class level.
We also need to measure the benefit more rigorously and here the concept of the reference portfolio (the ultimate KISS solution) has value. When I started in the business all those years ago, a primary benchmark at the Total Fund level was a reference portfolio made up 60% UK equity and 40% government bonds. This was the simplest default portfolio and if we couldn't beat that over time for a commensurate or lower level of risk then we had failed: our complexity had not been rewarded. Sometime in the 1980s the concept of the reference portfolio was lost but I am delighted to see that it has made a welcome comeback in recent years. It is the perfect way of striking a balance between KISS and over-complexity.
So, if we have to have an acronym to guide us, let's move from the more pleasurable KISS to the less memorable COIR: "Complexity, only if rewarded". Suggestions for a more mainstream less coconut-oriented acronym would be welcome.
I am a Partner in Aon's investment consulting team. I provide expert investment advice to a number of Aon's clients and contribute to the development of their intellectual capital.
You can contact me via my blog editor Anna Rudgard
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