Prepare, don’t predict: why uncertainty isn’t the enemy

At a glance: While headlines often claim uncertainty is at an all-time high, historical evidence suggests that uncertainty doesn’t necessarily lead to weak long-term returns. Over-hedging or cutting risk excessively can undermine long-term objectives. Investors can be compensated for taking certain risks, and constant risk reduction can dampen portfolio performance. Forecasting can fail due to overconfidence and behavioural biases. Instead of betting on one outcome, the focus could be on building resilient portfolios that can handle a range of scenarios. We believe that strong investment beliefs and scenario planning can help mitigate regret and hindsight bias, reinforcing diversification as a core principle.

 “Uncertainty is at an all-time high.” It’s a phrase that dominates headlines – but is it really true? And more importantly, what can investors do about it? Periods of crisis always feel exceptional. Wars, trade tensions, politics and recent pandemics have made today’s environment seem unprecedented. Yet many indicators of uncertainty and risk are not particularly elevated. And even if they were, history suggests that uncertainty doesn’t automatically translate into poor long-term returns. Volatility may spike, but markets adapt. The real challenge isn’t uncertainty itself – it’s how we respond to it.

Nip and tuck: reckless prudence

When uncertainty looms large, the temptation is to retreat. To hedge a risk here, to cut positions there. To become so risk-averse that long-term objectives are quietly undermined. That’s what we call reckless prudence. Ultimately, we believe investors are compensated for taking certain risks in markets. Those with long-term investment horizons can typically afford to ride out the noise. But if you can’t tune out the noise, or your investment horizon doesn’t allow you to, you face a choice: to hedge geopolitical risk or to harvest the potential risk premium it creates. On some occasions, hedging the risks may may prove to be highly effective, but a constant reduction of risk taking will dampen the ability of any portfolio to meet return requirements, as most risks do not unfold in reality. 

Why forecasts fail when we need them most

Recent years have exposed the limits of prediction as events repeatedly defied neat forecasts. But this is nothing new. Studies show that for decades, the confidence of professional forecasters regularly outweighs their correctness. Overconfidence isn’t always a bad thing, it’s part of a set of behavioural biases we rely on it for daily social cohesion, and quick decision making. But behavioural biases cloud complex investment decision making. Rather than focus on trying to accurately predict the future, we aim to prepare for future outcomes, using a structured team and process designed to counter destructive behavioural biases. For dynamic portfolios, we believe flexible asset allocation can exploit opportunities created by other market participants, by leaning against investor overconfidence and fragile consensus narratives. 

The real risk: regret and hindsight bias

When the dust settles, at the end of a week, year, or lifetime of investing, we will only have seen one realised path for markets. Yet in investing, we need to make decisions for a wide range of possible future outcomes over those time horizons. Many of those decisions won’t add value, in fact many will detract. In hindsight, they may be judged as incorrect, but with foresight they were designed to manage and limit the extreme range of possible investment results. 

Similarly, for investors diversified across a wide range of assets, the good news is they’ll never have very large exposure to those that do worst. But the problem is they won’t have concentrated exposure to those that do best, either. This is the real cost of diversification. Regret. Strong investment beliefs underpinning any investment strategy can reduce regret risk, and as we head into new waters of geopolitical uncertainty, diversification remains our leading investment principle, despite the costs.

Embracing uncertainty

Accepting uncertainty upfront should not be seen as capitulation. It frees us from chasing false precision and allows sharper focus on preparation. Rather than betting on any one outcome, our philosophy emphasises building resilient portfolios that can weather a range of futures. This sits at the heart of our  approach to asset allocation. 

By admitting that many economic and political processes are poorly understood in real time (inflation, for instance, has deceived forecasters for decades), we avoid false confidence. This means shifting from trying to foresee one definitive outcome to preparing for many. The goal is not exceptional performance in any one scenario, but good outcomes for investors, no matter which scenarios become reality.

Process in practice

Through learning, time and repeated application, we have honed our methods of scenario analysis. We use clearly defined, forward looking scenarios to map expected economic events and asset class returns. This means we record and document trade ideas with scoring, rationale and signposts in advance. We detail what evidence would shift our view, to avoid mission creep. We think and communicate in numerical probabilities, not vague words. We replace terms like “a high chance” with quantified probabilities (e.g., “75% chance”), and we aim to update our probabilities regularly. We apply the outside view and base rates from history to anchor expectations, even for seemingly unique events, and adjust those with the inside view that makes them relevant for today. Finally,  we aim to consistently learn from mistakes with honest post-mortems on both our correct and incorrect views of the world. 

This introduction sets the stage for a deep dive into how we apply our Prepare, Don’t Predict mantra into a 10-point guide specifically to geopolitical risks, and we conclude with a timely case study with a live example of prepare-versus-predict thinking in action. 

 

Assumptions, opinions, and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.

It should be noted that diversification is no guarantee against a loss in a declining market.