Most investors cannot clearly articulate why investment management is so hard. There is the superficial response that it is hard to beat a benchmark, but there is less discussion on why. Of course, costs are very relevant but the difficulty is also associated with the environment faced by investors.
A deeper meta-view for how the financial world works is needed to help describe the risks and challenges of investing. There is an expression that is used by the US Army to describe battlefield conditions or strategic environment for planning - VUCA, (Volatility, Uncertainty, Complexity, and Ambiguity). VUCA more aptly represents what investors face. This acronym is far more descriptive than the Clausewitz idea of a "fog of war" and serves as a good starting point for describing the investment world and the difficulties faced when making decisions.
VUCA is a deeper description and more illustrative of the often quoted language teaser by Donald Rumsfeld:
There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know.
Investors live in a VUCA world. The VUCA description for the environment provides a richness concerning the investment problem that is not captured with just saying that investors are faced with higher volatility or that there is a chance for black swans. Volatility tell us the behavior of prices, but does not tell us much about the decision problems we face navigating the investment environment. It is highly important and relevant as a measure of risk but it does not tell us what may cause the environment to be more volatile or why risks may increase. Saying that black swans may occur and that we will be surprised is all true, but does not provide insight on why we may be unprepared for these unknown surprises.
Describing the environment as VUCA provides more nuance on the type of risks faced by investors. It incorporates both the measurable within volatility and the subjective and not easily measured or countable with uncertainty. Complexity tells us something about whether the investment environment can be simplified or easily described while ambiguity provides a description on that which cannot be easily modeled. Ambiguity tells us that there are competing models that can both explain the facts but cannot all be right. Complexity tells us that no single factor or small set of stable factors can explain the variation in returns.
We are now seeing this concept of VUCA incorporated in broader strategic planning. (See Harvard Business Review, "What VUCA really means for you.") I am not comfortable with the definition applied to VUCA in this case given the focus is on business strategy and not the investment environment, but the table does highlight some of the key points that investors need to think about within a VUCA framework.
VUCA focuses on the idea that there are two dimensions to strategy problems: how much do you know about a situation and how well you can predict the possible results of your actions. This ties knowledge with results in a way that most investors do not usually frame.
The VUCA framework for describing the investment environment needs to be further operationalized, but it does provide a good starting point for discussion. Talent and costs are key drivers for investment success but they are limited by the environment faced. In a more ambiguous, uncertainty, and complex environment, success is more difficult to achieve but is also more likely for those that are prepared.