Many readers will be familiar with the challenge of office temperature. Some team members think the office is too hot, and others too cold. It suggests that our experience of temperature is based on perception rather than reality.
As an experiment, try the following:
- Fill a bowl with tap water
- Put one hand under a hot tap for a few minutes
- Then put both hands in the bowl of tap water
The bowl of water is the same temperature but one hand will feel colder than the other.
The fact is that our experience of temperature is based on perception.
I would argue that complexity is the same.
I have blogged before about how people can become comfortable with complexity (for example, getting on a plane). But the reality is that everything in the world is as complex as you want to make it.
When we are writing we don’t question the complexity of the physics of the bit of paper and pen that makes it possible. We are just used to it.
When we type an email we don’t question the complexity of the electronics that make it possible. We are just used to it.
One of the common things we get asked is about the complexity of derivatives. I have always found this understandable, but strange. My team and I would argue that investing in equities is no less complicated than using derivatives. However, we are, of course, just used to it.
If anything, my (clearly biased) view with my engineering mind is that derivatives are less complex than equities. Derivatives are essentially a piece of paper with a formula on it. That formula sets out exactly what you are going to get and in what scenarios. For someone with an engineering or maths mindset, this is far less complex than equities (a bit of paper with no definition of what you are going to get). For others, this sounds difficult. The complexity of derivatives is a perception.
So how do we go about overcoming that perception?
For me, it is firstly about building up from what is most important: a pension scheme’s needs. Secondly, it is to understand the behaviour of derivatives that help a pension scheme meet these needs and thirdly showing that this behaviour is reliable.
The second factor here is the complexity trap that many fall into.
The easiest way to explain behaviours to those of us with a technical mindset is by using formulae and algebra. But, to those not of the same mindset, this is likely to be the surest way to reinforce a perception of complexity.