Page 52 - TheManger09092011

This is a SEO version of TheManger09092011. Click here to view full version

« Previous Page Table of Contents Next Page »
— INVESTMENT ADVICE —
THE BACK OFFICE
the
manager
AUTUMN 2011
remarkably short period) that volatile
markets ofer both benefts and
dangers – and that the real danger is
determined by how we react to them.
Te environment we seek to control
is deceptive to our mental machinery.
A well-known artefact of fnancial
markets is that the more frequently
you monitor returns, the higher the
proportion of losses you see. So the
stock market can appear extremely
risky when we judge it based on
single-month periods, when the
proportion of losses is 39 per cent. If
we look at returns from holding assets
for one year, we observe losses only 22
per cent of the time. Over fve years,
the proportion of losses drops to nine
per cent, making it seem fairly safe.
During volatile periods (such as the
one we experienced in August 2011)
the heightened feeling of short-term
uncertainty, and the fear it engenders,
can drive the market more than usual.
Tis myopic risk aversion has real
efects on long-term performance. In
particular it can mean that we exit
at just the times when markets post
their biggest daily gains, which can
have a disproportionate efect on
long-term returns. Financial risk
works both ways – you risk being in
the market during crashes and out of
it during rallies.
And yet volatile markets feel like
a call to action. While complacency
may be acceptable in calm markets,
when the market is gyrating wildly
it feels like we must do something.
Tis desire for action (the ‘action
bias’) can be seen in many arenas
of life. Take football, for example.
When faced with a penalty kick,
goalkeepers dive to either side of
the goal 94 per cent of the time.
However, 29 per cent of shots are
aimed at the centre, implying that
goalkeepers would probably achieve
more by doing less. We see similar
efects in investment portfolios; the
more investors trade, the worse
their net returns.
We published evidence of this in
one of our recent ‘Insights’ reports,
Risk and Rules: Te Role of Control
in Financial Decision Making
. In our
survey of 2,000 wealthy individuals
from across the globe, we examined
the role that self-control strategies
play in determining the success and
satisfaction with fnancial outcomes
and decisions. Tose respondents
with a higher desire for fnancial
discipline had lower fnancial
satisfaction. Amongst these, those
who didn’t use self-control strategies
also had lower wealth levels.
Attempting to time the market (as
a specifc strategy) appeared to be
responsible for a surprising number
of negative outcomes. Individuals
who attempted to time the market
both felt they traded more than they
should, and were less satisfed with
their fnancial situation as a result
(see Figures 1 and 2, overleaf ).
Tat survey also gave us insight
into strategies which do work.
Respondents believed that rules
(such as using cooling-of periods
and social support) are more
efective in their fnancial lives
VOLATILE MONTHS
in the fnancial
markets – such as the August we’ve
just been through – test more
than our ability to manage our
investments; they test our ability to
manage ourselves. However, with
an understanding of our specifc
behavioural vulnerabilities, we can
equip ourselves to sail smoothly
through the tempest.
Te recent volatility was not
unexpected. We might not have
known when (or from what region,
country or sector) it was going to
arise, but we could be sure that it
was coming. Anyone who invests in
long-term risk assets must expect to
live through days, weeks, months
and even years when their portfolio
experiences losses.
Just as there is no free lunch, there
is no such thing as a high-return,
low-risk portfolio. It is uncertainty
that generates a return above the
risk-free rate. Markets prices build
in the emotional cost of volatility.
By standing frm, you earn your risk
premium. It is in turbulent times
that our investment strategy is put
to the test, not only in terms of
asset allocation, but also in terms of
emotional control and foresight.
When crafting a portfolio, we think
about how it will perform in both
the best of times and the worst of
times, but we should also think about
how we will react to volatility spikes.
Recent events have shown us (in a
GREG B DAVIES, HEAD OF BEHAVIOURAL FINANCE AT BARCLAYS
WEALTH LOOKS AT RECENT TRENDS AND OFFERS ADVICE ON HOW
TO KEEP A COOL HEAD IN A VOLATILE MARKET
FINANCIAL
INSIGHTS
“There is
no such
thing as a
high-return,
low-risk
portfolio”
FROM