« Back

Lessons in Risk Management from GE

Financial planning is very 1990's, now it's about risk ontology.

Sun Tzu

Sun Tzu - 544 BC Investment Guru

All Battles are Won or Lost Before They are Fought[1]

The slow death of GE, now symbolized with its removal from the Dow Jones Industrial Average after 111 years, offers a number of lessons for individual investors and families in risk management.

In order to understand these risk lessons, it’s necessary to understand how dominant GE was and how far it has fallen.

The Roaring 90’s

It’s hard to convey the place that GE occupied in the psyche of America in the 1990’s.  It was one percent of the U.S. economy.  If Greenspan wanted a quick take on the economy, he didn’t talk to his economists, he called GE CEO Jack Welch.  (For millennials, Welch was a bar-room brawler version of Jeff Bezos.)

If you were in the markets in the 1990’s you watched a lot of CNBC.  GE owned CNBC through its stake in NBC, a fact that CNBC viewers would be reminded of when Welch would call in to tell the newscasters “he was watching”.

Of course, the rise of CNBC coincided with the tech bubble and its cheerleading lead many a plumber to quit his job to lever up and day trade CMGI.  Remarkably, GE did the same.

The firm expanded from manufacturing light bulbs and household appliances, into finance (big into finance), long-term care insurance, broadcasting, aerospace, plastics, movies, healthcare, renewable energy, and more recently oil and gas.

In 1998, GE’s total liabilities were around $310 billion.  Ten years later they were a little under $700 billion.

They’re now back to a little under $300 billion as the company gets sold off for parts.

Chart 1: General Electric Total Liabilities

risk management GE chart 1

Source: Bloomberg

The death of GE has been in process for years for anyone who cared to notice.  The fact that the stock was over $32 at the end of 2016, just 18 months ago, now seems improbable.

Chart 2:  General Electric Stock Price

GE chart 2

Source: Bloomberg

Breaking: A Lot of Your Total Wealth Might Be Highly Correlated

The fourth largest holder of GE stock is the GE Retirement Savings Plan, which holds over 334 million shares, or 3.85 percent of the outstanding stock.  Likely these are GE 401(k) plan participants, many of whom will have much more than 3.85 percent of their account in GE stock.

That was a self-inflicted wound.

However, it is easy to understand.  The hardest risks to see are the ones investors are closest to, and the risk from your own firm is very close to you.

Furthermore, these employees had lost the battle before it was fought.  As I have explained in my Risks for AmLaw 100 Partners blog post series, these GE employees likely faced tremendous Company Town Risks from working at GE and living in towns where GE was a dominant employer.

Voluntarily adding to that risk by owning GE stock in a 401(k) plan was insane.

Now GE is selling off units and laying off employees.  If you are one of the unfortunate workers being laid off, you are losing your source of income, have likely experienced a significant decline in your 401(k) plan, will have a smaller pension than you thought, and could see your home value decline right when you might have to sell it.

For these employees, all the components of their total wealth have become correlated and are heading down at the same time.

Lessons for the Ultra-High Net Worth

What has happened to GE and their employees is not isolated to blue collar workers on the second shift at some plant in Ohio.

For instance, if you are a partner at a New York City law firm, you probably have many of the same exposures to your firm that the blue collar worked did to GE.  Those include: sole income source, equity investment, and pension exposure.  Plus you likely have unlimited liability from being a general partner.  While your home price may not be as highly exposed, it will be cold comfort if your employment gets terminated.

“Financial Planning” is Very 1990’s, Now it’s About Risk Ontology

A critical step is to undertake what I call a risk ontology.  This process seeks to understand all the risk exposures an individual or family has and how those risks relate to each other.  Once that is understood, the next step is to find ways to mitigate those risks in the most effective and least disruptive ways possible.

This process requires painstaking research and deep dives into all aspects the balance sheet.  In my experience, very few advisors understand this process, let alone undertake it.  Most of what passes for “financial planning” is really just moving around the investment furniture with some integration for tax and estate planning purposes.

This is wildly deficient and can unwittingly be harmful.   When financial asset diversification gives a false sense of security and the larger, hidden, risks have been left unaddressed, the battle has been lost before it was fought.

Please contact Bantam CEO Jack Duval to discuss how we undertake risk ontologies for our clients, or see how we’re redefining financial planning with our Family Strategy Books.

Schedule a Consultation

Sign Up for Our Blog

__________

Notes:

[1]      This is a popular paraphrasing of a Sun Tzu quote: “Therefore a victorious army first wins and then seeks battle; a defeated army first battles and then seeks victory”.  Sun Tzu; The Art of War; Translated by Thomas Cleary; Shambhala; Boston & London; 1988; 91.

Print Friendly, PDF & Email
« Back