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Investment lessons from Donald Rumsfeld

by Andrew Frankling | Jul 01, 2014

This is the second article in a series about investing issues for charities and not for profits (“NFPs”).  For earlier articles see here.  Much of this series will also be generally applicable to most investors. 

In February 2002 then US Secretary of Defense Donald Rumsfeld made the following statement in response to a question concerning Iraq and weapons of mass destruction:

…there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns -- the ones we don't know we don't know.”  

The comment became both famous and infamous, depending on your views on geopolitics and, more trivially, the correct usage of the English language. 

This article isn’t going to focus on the politics, except to make the somewhat obvious point that geopolitics at times can drive a lot of investment market sentiment, particular in the short to medium term. 

But as some have noted in the 12 years since Rumsfeld made the comment, it is a rather pithy guide to thinking about the risks that fiduciaries face.

So how can Rumsfeld’s statement be tied into your investment governance processes, most particularly the investment policy statement (“IPS”)?  Tackling the 4 types of risks in order:

Known Knowns: You need to define goals, acceptable risks, distribution policy, asset allocation, responsibilities of each fiduciary group eg fund managers among other topics very clearly.  Think SMART and SMARTER style objectives.

Known Unknowns: Investment Markets.  Regulator behaviour.  Protecting your charities brand.  These are often less measurable than your known knowns but can still be well managed by reading widely, using current awareness tools (eg and regular engagement with a diverse cross section of your stakeholders.  A good rule of thumb is to avoid undue complexity, unless there is a sustainable advantage to your organisation by taking it.

Unknown Knowns: Interestingly, and somewhat ironically, Rumsfeld forgot to mention these.  These are the risks are you did know about but have now effectively forgotten.  They are best minimised by effective protection of your organisational memory, through for example effective initial and ongoing training of fiduciaries and staff, as well as periodic risk reviews.

Unknown Unknowns: Whilst you clearly can’t write these down, how well known throughout the organisation are the mechanisms for escalating these?  Does the culture flowing from the Board encourage proactivity and are the fiduciaries truly happy to respond in “market time” where necessary rather than the timeframe of Board meetings?  Once they have emerged, pay particular attention to the risks that, right or wrongly, stakeholders may expect you should have been managing. Finally, what percentage of your portfolio needs to be both highly liquid and fairly capital stable to support your medium term operational expenses when the next big unknown unknown arrives?

It is not possible in an article to go into much of the detail that should be considered.  With this in mind, an IPS Checklist has been developed as part of the range of the tools that FIIG has developed for clients.

Please contact our NFP team Justin McFarland, Tim Smith or Casper Wolski on (02) 9697 8721 for more information.

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