New York, February 20, 2013, Advisor Update®
Behavioral Finance has become an important tool for investment managers, financial advisors and fiduciaries. Classical economics theory posits that investors act rationally, but the truth is the opposite. First, investors are far more interested in risk avoidance strategies than gains-seeking strategies. Yet they constantly overstate their comfort level with risks when risk markets are going up. This leads to herding mentality and eventually grave disappointments like 2001-2002 and 2008. Second, investors are hardwired with certain biases that make investment decisions difficult.
One bias we’ve highlighted here with some frequency is “Availability Bias,” where investors give priority to “new” information on an investment “theme” despite having a thorough grounding in asset allocation principles by their financial advisor. The media and their masters, advertisers, prey on this bias and the result is short-term pursuit of “hot” investments to the detriment of a long-term plan.
Not surprisingly, financial institutions have begun working with Behavioral Finance professionals, incorporating Behavioral Finance principles into their research. Here is an example aimed at financial advisors and their clients from Barclay’s Behavioral Finance group:
Sources: Barclays Bank, PLC and JAForlines Global
Global Tactical Asset Allocation investing requires a full Behavioral Finance toolkit too: we fight to avoid biases and pundit influence on our thinking. Financial television is full of breathless “experts” worrying about the meaning of 200 day moving averages, trend reversals and whether the Yankees have enough pitching this year. Well, the last one is worth a thought anyway.
The calculus for 2013 investing seems to be set as far as we‘re concerned. If a recession can be avoided in the US, and China hits a moderate GDP growth target of 7.5%, then this will be a solid year for a diversified portfolio which largely avoids government bonds. One of our favorite macro economists, Scott Grannis, agrees:
I suspect that, as long as the economy avoids a recession, and non-cash and non-Treasury investments continue to underperform the returns on risk assets, people increasingly will review their current asset allocation and conclude that they are being too conservative. They are passing up much higher-yielding alternatives because their assumptions about the future have been proven too pessimistic. People then will attempt to move money out of cash and into just about anything but cash: into real estate, corporate bonds, stocks, and commodities. The attempt to move out of cash and into riskier assets will cause the price of riskier assets to rise, and their yields to decline. Eventually, the Fed will be forced to raise the yield on cash until market expectations come back into some sort of equilibrium.
There are many things that could go wrong in 2013, but most of you already know what they are. It’s what could go right that seems to be in short informational supply. But no one watches TV to be bored, which implies many investors seeking “answers” are watching the wrong shows.
Please email us your comments, questions, etc.
John Forlines III