All too often, people navigate the investment terrain like a driver looking in the rearview mirror. They invest not on the likelihood of what will happen but on the basis of what has happened.
This misguided investment "method" isn't confined to amateurs. Many professionals are equally guilty. But many aren't. While most investors measure risk only in terms of how certain types of events and trends have affected investments in the past, well-funded investment firms are constantly looking forward. Their teams of highly paid economists look at the risk that identifiable scenarios might have on virtually any type of industry or company and the investments in them.
Whether it's increasing economic growth, a terrorist attack, a decline in the price of gold, a change in the majority of one house of Congress, the fiscal cliff or what-have-you, these professionals quantify the likely impact on domestic and foreign stocks, corporate bonds, Treasuries — you name it.
These analysts don't produce rigid projections. Instead, they project a range of likely impacts, from mild to heavy. After all, they're assessing investment risk if certain things happen rather than predicting events and outcomes with certainty. Whether these firms view these impacts as bad or good depends on what side of a particular investment they're on. If they're buying stocks, a heavy hit would be bad. If they're shorting, this impact might be positive for them.
A relatively new, small company is doing something similar, only in simpler terms, producing software that investment managers can integrate into their client portfolios. This product, born after the 2008 market meltdown — when investors who had long ignored risk suddenly couldn't get enough risk management — is Hidden Levers, software that investment managers use to stress-test client portfolios against different degrees of impact of economic trends and specific hypothetical events.
"You don't want to be a doomsayer or Nostradamus," says Raj Udeshi, one of the New York company's founders and a former trader. "Good economic research can indicate the best- and worst-case scenarios — bookends of what might happen. The key is, look at all potential investment outcomes from a given event, trend or development — from the best- to the worst-case scenario."
Hidden Levers is so named because, after its innovative software is interwoven with a graphic representation of an individual's investment portfolio, users click on and slide levers next to each of the various possible scenarios. They can then see potential quantified impacts on each of their investments, ranging from mild to severe.
The product's reception among investment managers has been highly successful, and the product has achieved significant advisor trade-press buzz.
In a departure from the typically stuffy world of market analysis, this is a product with a sense of humor. For example, impacts are categorized as to their severity as "the good, the bad and the ugly," and heavy-loss scenarios as "Thelma and Louise" – a reference to the movie in which Geena Davis' and Susan Sarandon's characters plunge into the Grand Canyon in a Thunderbird convertible. Thus, the software provides relative-scale impacts that are readily identifiable by the average individual.