Are You Worried You’re Making the Wrong Investment Decisions?

On this special episode of The Long View, guest hosts Dan Kemp and Ollie Smith sit down with Joe Wiggins, author and CIO of Fundhouse.

Here are a few excerpts on behavioral science, decision-making, and U.K. equities from Wiggins’ conversation with Kemp and Smith:

What Are the Most Challenging Decisions Investors Are Currently Facing?

Kemp: Joe, we’ve talked already about so many different types of decisions, so the decision of when and how to invest, the decision of buying different funds, the decision of dealing with these challenging market conditions. You’re in the business of making decisions and working with teams that make decisions. What are the most challenging decisions that you’re facing at the moment? And possibly, even more importantly, how are you approaching those decisions to get the best outcome?

Wiggins: Good question. It can really feel like a new world for many investors at the moment, because we’ve been through a significant period where the financial markets seem to work in a certain way, and none of that’s changed because of the specter of the realization of high inflation and the change in cash rates and government-bond yields. It feels like our go-to reference points or response functions that we’ve learned over our careers are broken or have certainly changed significantly. So, that can be quite disconcerting.

I think a couple of things that have been on my mind and on our team’s mind with regards to asset-allocation decisions—one is about bonds. So, are they attractive? Yields are significantly higher now, but so is inflation, and we might be heading into a recession. The other part is U.S. equity markets relative to other developed equity markets and emerging markets as well, there’s a major valuation gap that persists between those things, and that’s something that hasn’t really come out in the wash as the value growth dynamic changing has over more recent months. And I think I try and approach these decisions in the same way.

And I think there’s three elements I’ll try and think of at top level, or three principles, should we say. One is: don’t make aggressive macro forecasts. I don’t want to be predicting macro events. There’s very, very high chance that I will be wrong and a chance I’ll be wrong twice, so I’ll be wrong about the macro forecast and wrong about how markets will react to that macro environment. So, avoid making aggressive macro forecasts. Second is: whatever decision you make, don’t bet the whole farm. The reason that we diversify is because the future is uncertain. If we were certain about what was going to happen in the future, we only own one security, because we would know and be right about the outcome of that investing and that security. Diversification is a reflection of the fact that we are uncertain. No matter how high conviction my view is, there’s still a decent chance that I’ll be incorrect. I need to make sure that that is part of any investment decision I make.

And the other part, I think, which is really important, particularly when there are very persuasive and all-encompassing narratives in markets at a particular point in time, that is to try and focus on the base rates around decisions. So, what I mean by that is try to think less about the inside view. By the inside view, I mean the specifics of the particular story of the moment, a particular situation in market. Will the Fed pivot, for example? Try and move away from those types of decisions and predictions. It’s a complex adaptive system. That means it’s incredibly difficult to predict. Don’t do it. And think more about what history and the general weight of evidence tells us about a situation. Rather than saying how I think U.S. equities will perform against other developed market equities over the next six months, I have no idea. Think about the whole historical incidence of large regional valuation gaps, do they matter and why, over what time horizons do they matter, and try and base your decision on that. So, what I’m trying to do, generally speaking, is think about probabilities and trying to get the odds on my side. If I get the odds on my side and minimize the risk of disaster, that’s probably where I want to be rather than making bets on certain outcomes.

How Can Investors Make Decisions Without a View on the Macro?

Kemp: And so, by implication there, it’s that when you’re making macro decisions, then the odds aren’t in your favor. When you overinvest, then that’s when you open yourself up to disaster. Is that the idea there? Because I know that some people would say in response, well, how can you make an investment decision if you don’t have a view on the macro? But it’d be great if you could just unpack that a little bit.

Wiggins: I think, it’s being clear about what your view is. I think the shorter your time horizon, the more you’re making some kind of macro prediction. So, be clear about what your time horizon is when you’re making that decision. And I would say for the decisions around corporate bonds, whether they’re attractive at the moment, or developed-market non-U.S. equities versus U.S. equities--I think you can focus on the valuations, the long-term returns, if you’ve got the right type of time horizons. The shorter your time horizon, the more you’re likely to be making macro-orientated or sentiment-driven forecasts. Building in a time horizon to the types of decisions you’re taking is really important to me. I don’t want you to be making one-year macro views. I want to be talking about valuations and how they might impact returns over five, seven, 10 years.

Narratives and U.K. Equities

Smith: Joe, I was intrigued by what you said about narratives, and really how tempting they can be. I think just focusing on the U.K. for a second--one narrative that’s been bubbling away for a long time is just how attractive the U.K. is as a place to invest and particularly, U.K. equities. I wonder—I do have to ask you this—as a former employee of Aberdeen, how does it feel to see that company go through such turbulence? And I think the time of recording, the company has been readmitted to the FTSE 100. But it’s looking like a sorry story at the moment. What’s your view on that?

Wiggins: I think there’s a few things I would say. There’s probably general comments about certain types of asset-management firms. First, it’s hard being a midsized asset manager. The largest firms have the advantage of scale. Smaller firms have the advantage of more flexibility, putting more distinctiveness and more agency in how they behave. Being stuck in the middle is tough. And that’s why we’d like to see even more M&A activity in that space. It’s difficult being a midsized asset manager in an incredibly competitive environment where there’s huge pressure on margins.

Second is that for any asset-management firm distribution is so important, I think particularly for midsized asset managers. If you have inbuilt distribution, and that might be attachments to pension scheme or a life insurance business or a wealth management advisory firm—if you have inbuilt distribution, then you’re not fighting as much with 50 other asset managers for the same business, which is incredibly difficult to do and tends to be beholden to who has the best short-term, medium-term performance. So, distribution is critical, increasingly critical.

And finally, I think companies need to be better generally at defining their purpose. And I think when you talk about purpose with businesses, sometimes you can easily get involved in flummel and BS about meaningless purpose. But actually, at the underlying, it’s really important that companies need to define exactly what it is they want to be, and then design a plan or a strategy of how they’re going to execute that. And too often you see companies where you can’t really tell what their purpose is as a business. And I think that’s problematic because if you don’t have a purpose, it’s really hard to design the right strategy to meet your goals or objectives.