To put that somewhat deprecating statement into context, Meir Statman (a highly respected Professor of Finance) said in a recent interview with the CFA (Chartered Financial Analysts) magazine that “in every trade there is an idiot and if you don’t know who it is, then you are in trouble”.
Our industry finds that periods of turbulence or potential disruption, are an opportunity to not only self analyse, but also to analyse the behaviour of investors. Behavioural Finance is the official name for this type of analysis, but essentially it is about scrutinising how investors react in different market conditions versus how they are predicted to react and also what they expect us, as their investment managers, to be doing to protect their capital.
We have always ensured that risk analysis forms a central part of our discussions with our clients, but increasingly we need to address perceptions of risk and reactions to risk. For example, the last few years have been some of the most volatile and fundamentally damaging to the economy that we have seen in recent times. It has been interesting to watch how investors and their appetites for risk have changed during this time. Four years ago, significant investment volatility was an unlikely occurrence, but now it is at the forefront of people’s minds and so with hindsight and economic reality, there comes a change in attitudes and behaviour.
When the crisis began back in 2008, we would have been quite rightly regarded as financial geniuses if we could have preserved capital and prevented losses of any sort. As things turned out, we didn’t completely prevent any losses, but we did make strategic changes to our investment portfolios which minimised the losses and positioned our client’s portfolios well for a turnaround in growth prospects.
During the following 6 to 12 months, the markets began to recover and the rally of the FTSE began to take hold. As a result, investor’s appetite for risk increased and the question was then how can we fully participate in the rise of the FTSE within our portfolios and still keep pace with equity markets.
2010 saw a rally in commercial property funds and again human nature dictates that we should be increasing or adding exposure to the sector because that is where the money is to be made.
Over more recent times, markets have tended to trade within a range and with questions raised on a daily basis about the Eurozone in particular; investors have lost some of their optimism and are becoming more cautious again.
Throughout all of the above phases we have stayed true to our belief that diversification and remaining invested across a range of asset classes was the right thing to do. We are not about chasing a quick buck or selling down at the first sign of trouble – that is when you start looking around for the idiot who is buying.
Mr Statman’s other point was that investors want to be normal, sometimes they are normally rational and sometimes they are normally irrational, it doesn’t matter which, they just want to be normal and to behave how normal people should behave in different conditions. It is our job as investment managers to understand this, to bring risk to life and understand it so that we can help our investors make the right decisions. In addition, this knowledge means we can be confident in explaining the strategies we put in place for our clients through all market cycles.
Sometimes it is right to follow the herd and sometimes it isn’t, but what it most definitely isn’t about, is trying to be a hero and looking back in twelve months time to find that we were the idiots Mr Statman is referring to.
Risk is a topic we shall be discussing in more depth over the coming months; how we quantify risk, how it is reflected in our portfolios, how we consider risk when we make changes to our portfolios. If you have any questions or would like to discuss this with me, please contact me at jon.telford@msfs.co.uk
Tags: FTSE, Eurozone, Risk