‘Covid has intensified existing Gray Rhinos'

After Black Swan, the concept of Gray Rhino has caught the attention of market participants. Gray Rhino was a term coined by American author and policy analyst Michele Wucker after the Greek credit crisis in 2012. As investors increasingly look to understand the risks to their investment theories, the concept of Gray Rhino is gaining popularity .In an interview with ET ahead of the CFA Society India Wealth Management Conference, Wucker discusses the relevance of the concept.

Covid-19 has unleashed its own set of Gray Rhinos in the economy, financial markets and the society. What is the next big Gray Rhino for the world?
The virus not only intensified many existing gray rhinos like inequality and financial fragilities, but also exposed badly lacking health systems and social safety nets around the world. It has raised awareness about environment and the climate crisis, whose neglect has increased the rise of zoonotic viruses and compromised respiratory systems. It’s hard to talk about the next gray rhino because we’re still in the middle of all of these. So the real gray rhino is the mindset that has gotten in the way of solving them.

Majority of the investors--mainly money managers-- seem to identify more with Black Swan rather than Gray Rhino. Do you agree?

If you look at how much trading revenue was up this spring —more than 70% year-on-year at some of the biggest US investment banks— the answer is clear. Trading operations make money off of market volatility. And what better way to encourage volatility than to discourage policy makers and small investors from thinking ahead and reducing the severity of the swings between boom and bust? What better way for money managers to excuse bad decisions than to be able to say, “Oh, that was a Black Swan that nobody could have seen coming, so it’s not my fault I steered you wrong." What better reasoning for policy makers to use when they say “Nobody could have seen that anything bad could come of subsidizing stock market casinos through tax policy, extremely loose monetary policy, and turning a blind eye to risky behaviour.”

The virus not only intensified many existing gray rhinos like inequality and financial fragilities, but also exposed badly lacking health systems and social safety nets around the world.

-Michele Wucker

Volatility favours traders and experienced portfolio investors who are in the markets all of the time, who have access to real-time information, and who have cash on hand to swoop in during a crash and pick up distressed shares and companies on the cheap. Uncertainty and volatility hurt people who have to run the businesses that provide jobs and keep the economy humming. They also hurt small investors who do not have full information or the power to move markets, and who must rely on institutional fund managers to invest for them.

Investors are aware of Gray Rhinos, but in practice such risks are mostly overlooked. Have you been able to put a finger on this behaviour?
Investors overlook gray rhino risks for three reasons: psychological, structural, and incentives. Our cognitive biases often blind us to things we don’t want to see, including miscalculating cost versus benefit. Structural flaws often allow investors, managers, and policy makers to make flawed decisions and escape the consequences. Our incentive systems favour short-term behavior that in some cases makes gray rhino investment risks worse.

Do you have any advice for investors on how they can effectively use this concept to reduce risks and maximize returns?
The concept is most useful for investors who have a say in the decisions of the companies where they invest and can insist that management prioritise long-term thinking that minimizes bad risks, like taking chances with unsafe products or illegal activities, and optimises good risk taking that encourages innovation.

Ample research shows that short-termism destroys shareholder value instead of adding to it. In the short run, you might make a good profit by dipping in and out of companies, but this makes for unstable companies and economies which is bad for long-term profits.

China was the first country which officially acknowledged the concept of Gray Rhino. Did they apply this to coronavirus also?
The Chinese government has extensively used the Gray Rhino theory in its financial risk policy strategy and messaging since the book was published there in 2017. The governor of the Central Bank of the Philippines referred to Gray Rhinos in a 2016 speech on financial risk. Other governments and policy makers involved in financial risk, security, and disaster risk reduction, have engaged with the concept as well since early on, though not as publicly in China. Recently, nine US Senators invoked the gray rhino in a letter to Federal Reserve Chairman Jerome Powell about the need to account for climate change risk.

Despite early missteps when it was not yet obvious just how serious the novel coronavirus would become, China moved aggressively to contain the problem as the extent became clearer. Although I am not personally aware of any government references to the Gray Rhino in the context of the pandemic, it is clear that China has been applying its principles. I have received several requests from Chinese media in recent months, particularly on the economic consequences of Covid-19.

Have you been able to identify the Gray Rhinos for India?
The Gray rhino theory works best when people own the concept and its application rather than looking to others for answers. So I hesitate a bit to answer because people in India are the ones best placed to identify their Gray Rhinos, which often are different for each sector of the population and economy.

However, I follow Indian media coverage of the concept and have seen people apply it to corruption, infrastructure, digital disruption, digital addiction, geopolitics and more. I follow water issues globally and know that it is an acute problem in India especially for farmers and in urban areas.