Different levels of uncertainty require different thinking

Uncertainty surrounds every decision we make. You cannot get away from it. Investors should develop a best forecast for the expected return of an asset; however, there is still residual uncertainty. This would be the information or analysis that cannot nailed down or given a precise answer within our forecast. While Hugh Courtney from McKinsey discusses residual uncertainty for business strategy decisions, the framework can also be applied to thinking about investment decisions.  

If we analysis is done with a clear future, then single view thinking is workable. This is often used by most analysts. Incorporate best estimates and guesses, discount cash flow and form a view. It is easy but does not really account for uncertainty or the possibility that there are alternative solutions or futures. 

Level 2 uncertainty accepts that there are possible alternatives to our best guess, but they can be limited to specific unknown situations. The simple approach would be to account for an upside optimistic and downside negative case relative to our best guess. The good and bad scenario is a standard approach that does not focus on the core issue that specific factors or assumptions have more uncertainty than other factors. Limited focus on uncertainty is easier to deal with because specific uncertainty or unknown can be the focus of our attention. 

Level 3 uncertainty acknowledges that there is a broad range of possibilities. There several alternatives that cannot be defined or be associated with a few simple factors. While acknowledging many alternatives is helpful, the problem of dealing with multiple alternatives creates a difficult forecasting environment.

Level 4 uncertainty is not often faced, but this could be associated with new technology in a new industry. In this case, the range of outcomes may not be handicapped. Any forecast will only have a small chance of success, so extra compensation is necessary to engage in this type of investment.

Investors will benefit from trying to handicap the residual uncertainty faced after a best-efforts forecast is projected. The source and number of uncertain futures is necessary to handicap returns and place a true measure on risks taken.