The Conundrum of Responsibility vs. Accountability

by Frank Muller

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I’ve always felt very strongly that, when it comes to investments, all things revert to the mean. This assumes that there is a long-term symmetry and balance and that our journey is merely the roller coaster ride up and down the ultimate mean of events. The good news is that the mean is upward sloping and, therefore, we can have hope and faith in the eventual outcome. But the peaks and valleys that get us to that mean can be remarkably high and low.

We have often discussed the destructive force to investment portfolios when investors—and even their advisors—succumb to the fear or greed impulse. What is not often discussed, however, is the interplay between accountability and responsibility and how that aspect of the human condition has an equally powerful influence on portfolios.

To me, accountability suggests the willingness to track and report our actions, while responsibility suggests personally owning the results that those actions were expected to achieve. Interestingly, it is human nature to bounce between these roles, depending on the situation.

In general, people who are the beneficiaries of a given action demand results at the level they expect. For example, take the occasion of dining at a fine restaurant. Our expectation is that the overall experience—from the valet, to the hostess, to the bartender, to the waiter, to the chef, to the physical ambience and cleanliness of the restaurant—will meet or exceed our expectations.

If our expectations are not met, it comforts us little if the entire staff can produce accountability reports proving that they met the internal standards of the restaurant within each of their respective areas. In this case, the customer demands responsibility, but the restaurant employees want to provide accountability—which is what they individually can control. Hmmm … imagine that.

Depending on whether we are the customer or the provider, we personally shift between either wanting to show that we did all that was required or demanding that the expected result be achieved.

How does all this relate to investment management and, in particular, advice providers? First, it suggests that we must recognize that human beings are a yin and yang of beliefs and actions. It is not enough to understand that fear and greed may compel irrational decision-making. Secondly, we must recognize that, from their perspective, investors are ultimately disinterested in the metrics we can show to demonstrate that our service standards were met relative to some established benchmark. This is akin to an airline saying they have a 97 percent successful baggage rate. Tell that to the three percent standing in the lost luggage line and see how satisfied they are.

Finally, we must understand that investors want an experience that meets or exceeds their expectations. With regard to portfolio construction, this suggests that we must design portfolios to exceed investor expectations in a positive way when markets correct or crash, while still achieving the real rates of return they require to meet their long-term financial goals. Unlike the airline industry, where lost luggage is a one-in-25 occurrence, market corrections or crashes are near a 100-percent certainty in our industry.

We may believe that we are accountable and can justify the soundness of our actions, but a client’s expectation is one of responsibility to the goals she has in mind in that future moment of fear—not in the “present” moment when her expectations are at the mean.

In my opinion, there is only one way to reconcile portfolio management with these aspects of the human condition and that is to expand the definition of diversification to incorporate sufficient diversifiers that may reduce portfolio volatility in times of market distress. This not only addresses the fear/greed dynamic, but it may also help to address the professional conundrum of responsibility versus accountability.