10 Things Fund Managers Say and What They Actually Mean

Communication is a major problem in the fund management industry.  Whilst financial markets exist in a state of constant uncertainty and flux, asset managers talk with unwavering confidence.  Their utterances are driven by the sales imperative and a general reticence to admit mistakes. They therefore often require some unraveling to get to the true meaning:

Below are some favourites (with translations provided):

“ESG is in our DNA”

“We have always done some company management meetings, but have started to take environmental and social factors seriously now we can see it sells”.

“What we have witnessed is a 10 standard deviation event”

“This didn’t show up in our backtest”

“We don’t have a specific capacity limit in mind for this fund, but we can say that our current asset size has had no impact on our investment process”

“You must be mad if you think we are going to close down this revenue stream”.

“Private equity and ESG are a natural fit”

“We hope you haven’t noticed that the private equity model has largely been built on shareholder value creation at the expense of other stakeholders”

“We are benchmark aware not benchmark constrained”

“We are benchmark constrained”.

“The rise of passive investing and quantitative easing has materially distorted how markets function”

“Performance hasn’t been great”.

“The performance fee structure means that my interests are perfectly aligned with my clients”

“If I can just have one or two good years then I am made”.

“Active management will prove its worth in the next bear market”

“I wonder if I can appeal to your loss averse tendencies”

 “Cognitive diversity is incredibly important to us” 

“We have one woman on the team”.

I am genuinely excited to join this company, with the resources they have and the freedom they give fund managers, it is a great place to run money”

“They offered me a share of revenues”


 

 

Are You Sticking to Your Investment Principles or Suffering from Escalating Commitment?

Our investment behaviour is a tangle of contradictions.  Whilst there is an understandable desire to draw clean lines of causality – X bias leads to Y action – things are rarely so simple.

One example of such confusion is the inherent friction between keeping faith with your investment principles and the problem of escalating commitment.  I often try to extol the virtues of holding a set of well-defined investment principles and maintaining them through the vicissitudes of economic and market noise.  It is clear, however, that a great failing for many of us is becoming increasingly devoted to a particular view in spite of reams of disconfirming evidence about the validity of that perspective.

Escalating commitment is a situation where an individual or a group persist with a course of action despite facing negative results and feedback.  This topic has been well covered by psychological research and there are some excellent meta-analytic reviews of the studies carried out in this area[i] [ii].

A research paper by Theresa Kelly and Katherine Milkman[iii] specifies four primary explanations for our propensity to double-down in the face of adversity:

Self-Justification Theory:  Repudiating previously held views is painful and creates a dissonance between our failure and belief in our own competence.

Confirmation Bias:  We actively seek information that corroborates our view or course of action.  We might be wilfully blind about the fact we are failing.

Loss Aversion: The crystallisation of lost time, money and credibility is deeply unpleasant. We weigh the sunk costs heavily when deciding whether to persist.

Impression Management:  How we are perceived by others is crucial to our self-worth and (in many cases) our career.  Changing our mind means admitting that we have erred and risks us being perceived as ineffectual or inconsistent.

The issue of commitment escalation is a particular challenge for investors because the feedback we receive (typically in terms of profit and loss) is noisy and erratic. Markets don’t consistently reward good decisions.  Sometimes they take time to work; sometimes they don’t work at all.  Whilst in many fields the failure of a project or decision is unambiguous, for investors it can be difficult to tell whether we are wrong or just not right yet.

This feature of financial markets creates a stark juxtaposition between the benefit that can accrue from persevering with sound investment principles, and the cost of the failure to abandon poor decisions.  How can I tell if I am diligently keeping faith with my investment approach or naively escalating commitment?

Is it an Investment Principle or Investment View?

The most crucial distinction to draw is between what constitutes an investment principle and what constitutes an investment view.

An investment principle is a belief that informs our decision making – for example, I may believe in regular rebalancing, or in long-term holding periods.  All of our investment decisions should be framed by these principles.

By contrast, an investment view is some form of explicit or implicit prediction or forecast about the future.  For example, it might be that there will be a recession in 2021 or that US equities will underperform other developed markets next year.

In reality, for most decisions it is not possible to specify a binary classification between an investment principle and an investment view; rather there is a spectrum between the two extremes.

At one end, an investment principle should be broad and supported by robust and clear evidence, and assumed to be invariable.  Of course, there may be times where an investment principle shifts or evolves but the threshold for such a change should be very high.  Commitment to a principle should generally be seen as a virtue.

At the other end of the spectrum is an investment view, which is specific and temporary.  Whilst it should also be supported by evidence, the threshold for change based on the receipt of new information should be reasonably low.  The probability of being wrong is significant and unwavering support is damaging:

  Investment Principle Investment View
Context General Specific
Durability Longer Shorter
Evidence Stronger Weaker
Confidence Higher Lower
Threshold for Change Higher Lower
Commitment Positive* Negative

It is easy to think of examples at each extreme – I don’t buy funds with leverage (principle) / the market will fall 20% next year (view) – but many of our investment opinions fall somewhere in-between.  For example, let’s assume I believe that smaller companies provide a long-term return premium and are inefficiently priced.  As a result I place an active allocation to this area within my portfolio.  This perspective is neither purely a principle nor a view.  It is structural long-term rule, but is also specific and based on mixed evidence.

The closer an investment decision is to being defined as a view, the more the escalation of commitment becomes a challenge.  Whilst we should be willing to reconsider either a principle or view in light of new evidence, by definition our commitment to principles should be significantly more durable than our willingness to persevere with an investment view.

The escalation of commitment is particularly problematic for investors when they come to be identified by an investment view rather than principle.  Warren Buffett can be defined by a set of core investment principles, but many investors become known for a view.  This is most common with bearish prognosticators consistently forecasting recessions or severe market declines.  In such situations individuals seemingly operate in ignorance of new contrary evidence and their identity becomes intertwined with their particular outlook meaning that it becomes impossible for them to recant**.

How to Avoid the Escalation of Commitment

With any investment decision (wherever it resides on the spectrum between view and principle) one of the best protections against the escalation of commitment is a decision log.  This is a simple approach but one that seems to be applied sparingly.  Although the precise structure can vary; in broad terms a decision log should be a concise document detailing the key drivers of a particular decision at the time we are making it.  This should include aspects such as: what the decision actually is, the time horizon involved, the key supporting evidence and potential risks / threats.

Not only does a decision log provide some protection against our hazy and unreliable recollections of past investment decisions; it should also mitigate the danger of us becoming increasingly committed to an investment view.  If we are specific about the key drivers of a decision at the point of initiation it becomes far more difficult to become emboldened in our conviction as the evidence wanes.  Creating a decision log also forces us to consider the prospect of being wrong at the very start of a position, which subsequently makes it (somewhat) less damaging to our ego if this negative outcome comes to fruition.

Using a decision log is not, however, painless.  Looking back at what we previously believed when we made an investment decision can be a unpleasant experience; it’s far more agreeable to allow your memory to construct a flattering story about it.  This is perhaps why they seem something of a rarity.

There is no simple way to manage the escalation of commitment.  Taken to its extreme, bluntly attempting to negate its influence would lead to us all becoming short-term investors, destroying value at the first sight of trouble and abandoning sound investment decisions based on the meaningless fluctuations of markets.  Contrastingly, ignoring it would make us prone to increase conviction in failing ideas with scant regard for new evidence.  A more measured approach is required, where we better understand the nature of each decision we make and are clear about the reasons we are making it.

* Investment principles can of course be wrong and therefore commitment to them a negative. I am assuming here that the investment principles are robust and well-founded.   

** Whilst becoming defined by a certain viewpoint may often be imprudent and costly in investment terms, it can be a rational course of action for an individual pursuing such a strategy.  This is particularly true for those of a bearish disposition who appeal to the fearful nature of risk averse investors and of course will, one day, be right.  Also, the half-life of credibility for market crash / recession forecasters seems to be far longer than those of a more positive bent.

[i] Sleesman, D. J., Conlon, D. E., McNamara, G., & Miles, J. E. (2012). Cleaning up the big muddy: A meta-analytic review of the determinants of escalation of commitment. Academy of Management Journal55(3), 541-562.

[ii] Sleesman, D. J., Lennard, A. C., McNamara, G., & Conlon, D. E. (2018). Putting escalation of commitment in context: A multilevel review and analysis. Academy of Management Annals12(1), 178-207.

[iii] Kelly, T. F., & Milkman, K. L. (2013). Escalation of commitment. Encyclopedia of management theory, 257-260.

 

 

Stale Pricing Does Not Equal Low Risk or Low Correlation

Alternative asset classes are in something of a sweet spot. Not only do they offer the prospect of a diversifying source of return in an environment when bond yields are at historically low levels, but they also provide a new revenue source for active managers. In the current landscape, strategies where passive replication is problematic or impossible provide a particular allure for margin-pressured asset management firms.  Whilst the attention being lavished upon this area is unsurprising there are certain aspects of discussions about such investments, which are troubling and often misleading.

Alternative assets represent a broad church and can encompass anything that falls outside of the core traditional mix of equities and bonds, from private equity to fine wine.  The nebulous nature of this definition means that it is difficult and unfair to discuss the credibility of the grouping in general terms; however, one common feature tends to be the approach to pricing and valuation.  Whereas the majority of traditional assets are regularly traded and marked to market; alternative assets are typically far less liquid and, in the absence of a regularly traded market price, are valued on some form of model / appraisal basis.  This approach to valuation is not a problem in and of itself – there is often no simple answer to appropriately valuing such assets – however, it does have profound implications for how you might express the risks of such strategies and compare them to traditional asset classes.

The first, seemingly obvious, point is that volatility is a woefully inadequate measure of risk for most alternative assets, particularly if used in comparison with public equity returns, for example.  The pricing of any mark to model asset is smoothed; it is largely immune to the vagaries of human behaviour that drive the vacillations of listed assets – imagine the volatility of the S&P 500 if it was valued on a monthly basis based on projected future cash flows.  Volatility has come to be the primary term for how we express investment risk, even where it is inappropriate for the assets in scope.  This incongruence has been exploited by some to suggest that alternative assets in general terms are inherently lower risk, turning a structural limitation* into a sales message.

Deeply intertwined with the issues surrounding volatility and mark to model pricing in alternative assets is the issue of correlation and diversification.  Whilst some alternative assets will have genuinely distinctive attributes when compared to traditional equity / bond portfolios, these should be driven by the underlying economics / cash flow profile of the assets rather than the valuation methodology or liquidity structure.  The most egregious example often comes in the form of some private equity strategies, where a portfolio of private, medium sized companies can be said to offer material diversification benefits compared to a portfolio of public, medium sized companies.  Clearly, the holdings of the two portfolios are highly economically correlated, even if their differential approaches to valuation provide an optical sheen of differentiation.

The narrative supporting alternative assets is often built around the impact that their addition can have on a traditional portfolio (such as a 60/40); whilst there may be merit to this viewpoint, the primary evidence given is often fatuous. The argument tends to run as follows: ‘look at the beneficial Sharpe ratio and volatility impact of adding XYZ alternative strategy to your portfolio’.  Alternative assets exhibit artificially low volatilities and therefore abnormally high Sharpe ratios, they can also appear to have a low correlation to traditional assets – of course they look wonderful when added to a leaden portfolio of equities and bonds.

The problem is that as an industry we have come to use volatility and Sharpe ratio as default metrics for the analysis of traditional portfolios and are now prone to view everything through these frames even when their usage is entirely inappropriate.  Furthermore, given that many asset allocators are assessed on such metrics the rational course of action for them is to game these measures by utilising alternative assets with depressed volatility and low correlations to ‘enhance’ the overall results of their portfolios.

That is not to say that there is no role for alternative assets but any investment case for them should be driven by an understanding of their economic merit and cash flow profile, we should always ask – do arguments around diversification and low volatility make intuitive sense?  Such assets can appear low risk when viewed through a volatility lens – attractive in risk models and optimisations – but such smooth returns can often cloak an unpleasant tail.  Beware the dangers of mistaking pricing and liquidity characteristics for fundamental ones.

* As I have previously argued, one indirect benefit of illiquid assets is behavioural – if it is difficult / impossible to trade, we are more likely to stay invested for the long-term.

How Probabilities are Expressed Can Impact Our Investment Decision Making

Imagine you are in a team meeting discussing a potential investment with three colleagues, you ask them how probable it is that your investment thesis for a particular position comes to fruition, each of them states that they see it as ‘likely’.  In an alternate universe, you are in the same situation the only difference being the responses from your colleagues – on this occasion they each say ‘60%’.  Does your colleagues’ shift from a verbal to numeric expression of probability impact your confidence in the investment decision?  A new paper from Robert Mislavsky and Celia Gaertig contends that it would – their research suggests that when we are given numeric probability forecasts we average them and when given verbal forecasts we count them.  A succession of ‘sixty percents’ leads you to a 60% average, whereas a similar number of ‘likely’ responses sees your own view become ‘very likely’.

We often talk in probabilistic terms without realising it – when we state something is ‘likely’ or ‘very likely’ we are expressing some form of view on the probability of an occurrence, although it is admittedly a vague one.  Research around this area has typically focused on the comparison and translation of verbal probability expressions into numeric ones, and vice-versa – when we say something is unlikely, what probability do we actually mean?   As Mislavsky and Gaertig note in their paper, verbal probabilities have the benefit of being clear in their direction (you can tell if it is positive or negative) but suffer from imprecision, whereas numeric probabilities are specific but the direction is not always clear (whether a 45% probability is positive depends on the context).

Mislavsky and Gaertig’s research develops the thinking around this subject by moving on from identifying specific differences between individual verbal and numeric probability expressions, and showing that there is a material change in outcome when we combine a number of verbal probabilities, compared to when we combine a selection of numeric probabilities.  Their research incorporates a range of experiments (7 in total) wherein participants were required to make a decision or predict an outcome after receiving one or two expert forecasts – these forecasts were either both numeric or both verbal.

For example, in their second study, participants were provided with some details about a company and asked to judge how likely it was that its share price would be higher in a year’s time.  Some participants received expert guidance from advisers in numeric form and some from advisers in verbal form.  The results of this study – which were consistent with all the experiments carried out in the research –  was that “participants became more likely to make extreme forecasts as they saw additional advisor forecasts in the verbal condition but less likely to do so in the numeric condition”.  We can see this in the chart below:

Probability

The predictions of the participants clearly became more extreme when they received an additional verbal forecast but not when an additional numeric forecast was provided.  By ‘extreme forecast’ the authors mean when a participant’s forecast is in excess of that given by either adviser.  Similar results were observed when the study moved from looking at a hypothetical stock price, to predictions of Major League Baseball games with probabilities given by genuine experts.

There is clear evidence from the study that the verbal probabilities lead to a counting process, whereas numeric probabilities are averaged. There are good reasons for both approaches – counting works on the basis that each adviser is providing new information, whereas averaging is prudent if we assume each forecast is founded on the same information.  There is no requirement, however, to associate the different expressions of probability with different processes for their combination – two 60% forecasts could just as easily be driven by different information as two ‘likelys’.  So what is happening?

The authors conclude the paper by reviewing and largely discounting a range of potential explanations (I would urge everyone to read the paper directly).  My best guess of the cause of the phenomenon would be a combination of some of the factors mentioned by the authors, in particular how individuals are liable to perceive numeric and verbal probabilities in different fashions.  Numeric forecasts feel precise and objective, and more consistent with an ‘outside view’ driven by the base rate or reference class – more likely to contain all relevant information.  Contrastingly, verbal probabilities seem personal and subjective, more akin to an ‘inside view’ where an individual providing a forecast will be doing so based on their own unique knowledge or perspective – therefore an additive approach can seem justified.

This idea is pure speculation about which the authors are sceptical, however, whilst the drivers of this contrasting approach to combining probabilities are uncertain; the results, from this initial study at least, are clear, and there is an important lesson for investors to heed.  It is crucial to consider not only the type of guidance and advice we are receive when informing a decision, but how it is being expressed.  This is relevant whether it relates to an individual’s decision using a range of external information sources, or a team based decision making process where we are seeking to synthesise the insights of a number of individuals into a single view.

Mislavsky, R., & Gaertig, C. (2019). Combining Probability Forecasts: 60% and 60% Is 60%, but Likely and Likely Is Very Likely. Available at SSRN 3454796.

Active Management is Reliant on the ‘Inside View’

I have an investment decision to make.  I need to allocate money to a particular asset class and have to decide whether to use a passive market tracker fund to gain exposure or invest with an active manager.  The odds are not in favour of the active option – over the last decade only 10% of managers in the asset class have outperformed the benchmark – however, I have identified a manager with unsurpassable pedigree in the area, a fantastic performance track record and a robust investment process.  Which option should I choose?

The stark contrast of perspectives underpinning this question is an example of what Kahneman and Tversky would label as the ‘outside view’ versus the ‘inside view’[i].  The outside view in this scenario is that 10% of active managers achieve success in the asset class, and is what we can consider to be our base case or reference class – it provides a statistical framework for informing a decision.  My experience of being impressed by a particular manager is the inside view, which is developed using information specific to my individual case which, as Michael Mauboussin notes, may include “anecdotal evidence and fallacious perceptions”[ii].   We can broadly characterise the outside and inside view informing any decision as having the following features:

Outside View Inside View
Reference Class Personal Experience
Evidence Narrative
Similarity Difference
General Specific
Realism Optimism
History Current

Our general tendency is to focus on the inside view – we adore narratives, tend to believe that our own experiences are exceptional and are overconfident in our abilities.  Use of the inside view is particularly prevalent in the active asset management industry as, of course, it must be – if something does not work on average then it must be forged on the notion of edge, competitive advantage and exceptionalism.

The inside view is also so much more compelling – those wonderful and usually superfluous stories of active managers gaining an advantage by visiting the factory of a target company (it always seems to be a factory) or meeting management are both diverting and persuasive.  The problem is that they do not change the odds; rather they simply encourage us to forget them.  We often think that the additional insights from detailed research are improving our decisions, but in many cases they are simply making us neglect the base rate (whilst erroneously increasing our confidence)[iii].

Returning to the question with which I began this post; if I select the active manager option then I need to support that decision with one of two claims.  I can argue that the base rate is incorrect and therefore the odds are more favourable than they appear – there is something about historical experience which means it is not representative of the future.  Alternatively, I can accept the probabilities but possess such belief in my active manager selection capabilities that I am not concerned by them.  In most cases we don’t actually make either of these arguments explicitly, we simply ignore the outside view and make the case using our inside view – which is usually sufficiently captivating to overwhelm more prosaic considerations.

This is not to suggest that the inside view is of no merit, but rather it should be used only as a complement or adjustment to the outside view. Our starting point should always be a consideration of the reference class or general evidence that frames a particular scenario.  We can then revise this (usually modestly) if we obtain relevant information that is specific to our case.  A failure to follow this approach means that we will consistently make decisions which ‘feel’ right but where the odds are stacked against us.

[i] https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/daniel-kahneman-beware-the-inside-view

 

[ii] Mauboussin, M. J. (2012). Think twice: Harnessing the power of counterintuition. Harvard Business Review Press.

 

[iii] https://behaviouralinvestment.com/2019/01/09/can-more-information-lead-to-worse-investment-decisions/

Why Are So Many Fund Managers Men?

Citywire’s 2019 ‘Alpha Female’ study[i] reported that only 10.8% of the fund managers in their global database were women; a figure that has largely flat-lined since its first publication in 2016.  If we disregard the absurd notion that men hold some form of gender based advantage in the skills required to be a successful fund manager, then this represents a staggering anomaly.  There are inevitably deep-rooted societal features* that contribute to such disparities and whilst these are apparent across industries[ii]; there are also features and behaviours specific to asset management – and our perception of what it means to be a talented fund manager – which serve to exacerbate the issue. These must be acknowledged if we are to even begin to remedy the situation.

In her excellent book ‘Invisible Women’[iii] Caroline Criado-Perez highlights the idea of brilliance bias and research showing that “the more a field is culturally understood to require brilliance or raw talent to succeed…the fewer women there will be studying and working in it.”  She goes on to make the case that we struggle to associate women with being “naturally brilliant”. Criado-Perez cites areas where this bias presents a major impediment for women including: maths, physics and science, but this group could easily include active fund management – particularly given our long standing obsession with ‘star’ fund managers.

It is unquestionable that we are often in thrall of successful active managers.  Given how difficult it is for active managers to deliver excess returns; we are prone to laud those that do as possessing some form of exceptional or even innate investment aptitude (even where it may very well be luck). One of the (many) problems with this is that, as Criado-Perez notes, we are more likely to erroneously associate possession of such inherent talent with men.  There is also the complication that nearly all examples of this type of fund manager adulation involves men, which only serves to perpetuate and exaggerate the trope that those truly exceptional individuals able to buck the trends in active management are inevitably male.

Whilst brilliance bias is often focused on opaque and unexplainable characteristics – intangible concepts such as talent – the challenges faced by women seeking to enter the fund management industry are also caused by the wrongful assumption that certain (traditionally male biased) characteristics are associated with fund management skill, and these are often the very characteristics which overwhelm investor decision making.  This idea is eloquently put forward by Tomas Chamorro-Premuzic in his paper (and subsequent book) ‘Why Do So Many Incompetent Men Become Leaders’[iv].  Although about executive management positions rather than fund management roles the parallels are stark, and there is one particular trait which resonates pointedly – overconfidence.

We are liable to mistake confidence for competence.  This is especially relevant in the fund management industry where identifying the features that are truly indicative of skill is so difficult that we are likely to rely on how compelling or convincing an individual is.  Chamorro-Premuzic argues that the advantage granted to overconfident individuals presents two challenges for women attempting to attain leadership positions – they are generally perceived as less confident than men and if they do display ‘extra’ confidence we become concerned that they are not conforming to their gender stereotype.

A related concept highlighted by Chamorro-Premuzic is the influence of charisma, another feature which clouds our ability to judge an individual’s aptitude for a given activity – there are few things more dangerous in fund manager selection than a charismatic manager who has been lucky.  Although there is far less research around how gender impacts our perception of charisma, Chamorro-Premuzic argues that there is a circular relationship at play – more leaders are men, leaders are perceived to be charismatic and therefore charisma has come to be considered a male-dominated trait.  He goes on to produce a pertinent quote from Margarita Mayo about our attraction to charisma:

 “The research is clear; when we choose humble and unassuming people as our leaders, the world around us is a better place…Yet instead of these unsung heroes, we appear hardwired to search for superheroes: over-glorifying leaders who exude charisma”.

I could quite easily replace ‘leaders’ with ‘fund managers’ in the above quote and it would prove an appropriate description of the type of fund managers to which we are often drawn.

A report by capital markets think tank New Financial:  ‘Diversity in Portfolio Management’[v] explicitly attempts to identify the barriers to progression for women and those from diverse backgrounds within the asset management industry.  One of the 18 highlighted was the ‘loss of performance continuity through leave of absence’- this is a material concern and one which is directly related to our perception and glorification of star fund managers.  Our false perception of the archetypal successful fund manager as being a supremely talented individual with a unique skill set not only plays into tired gender stereotypes, but also increases the requirement to have named fund managers and avoid extended leaves of absence.  The belief that superior performance must be down to one individual who is constantly poring over the portfolio further raises the hurdle for women, who are more likely to have extended time way from the office due to factors such as maternity leave and the traditional division of childcare responsibilities[vi].  This imperils the ability of a female portfolio manager to develop an undisturbed track record as an individual, which is often valued highly by fund selectors, and seen as a ‘requirement’ for asset management firms to successfully market their funds.

Two other extremely valid issues raised in the report are the lack of meritocracy and the shortage of role models.  The meritocracy obstacle in fund management is caused both by asset management firms valuing the wrong characteristics (such as confidence over competence), and also the self-perpetuating tendency of people to hire individuals who are most like them – the mirrortocracy – if most fund managers are men, this becomes an implicit characteristic / requirement for such positions.  The lack of role models is a related and also pernicious problem (and by no means just relating to gender) – if the vast majority of fund managers are men, there are inevitably few role models with whom people of other groups can easily identify.

The causes of gender imbalance in the asset management industry are deep and structural, and far more complex than I could possibly hope to convey.  The purpose of this post is to highlight how asset management groups and fund buyers can be considered complicit in the under-representation of women in fund management roles because of our desire to identify, extol and sell ‘exceptional’ individuals (unfortunately almost always men) whilst being beguiled by gendered traits such as overconfidence and charisma – which have no proven relationship with the skills required to be a successful fund manager.  Until we start taking substantive steps to improve the situation – such as moving to a team based fund management culture rather than one focused on star individuals – progress in this area will remain glacial.

*These vary across region, there is an admittedly UK / US bias to this article.

[i] https://citywire.co.uk/new-model-adviser/news/alpha-female-2019-female-fund-managers-stuck-on-10/a1253711

[ii] https://researchbriefings.parliament.uk/ResearchBriefing/Summary/SN07068

[iii] Perez, C. C. (2019). Invisible Women: Exposing Data Bias in a World Designed for Men. Random House.

[iv] Chamorro-Premuzic, T. (2013). Why do so many incompetent men become leaders. Harvard Business Review22.

[v] https://newfinancial.org/diversity-in-portfolio-management/

[vi]https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/705898/Return_to_work-parental_decision_making.pdf

 

 

Your Investment Time Horizon Might Be Shorter Than You Think

I was recently asked by a friend for my opinion on UK assets following the renewed weakness in sterling and the general Brexit induced pessimism surrounding the UK economy.  I am deeply reticent to talk about this type of investment related issue outside of work; primarily because it usually ends up with the person wondering if I really have a job in the investment industry – I don’t know where markets are headed, I don’t have any good stock tips and have no unequivocal opinions on key economic issues.

Although it is inevitably a conversation killer, I instead try to turn to sensible and broad investment principles; on this occasion I said something along the lines of: “It depends on your time horizon, if you are investing for the long-term – like your pension – then buying unloved and undervalued assets can be a good idea, but if you are looking for a short-term trade the risk and uncertainty is extremely high”.   Whilst I think the general point here is sound*, on reflection I made a major behavioural omission, which I think is fairly common when thinking about time horizons.

When we talk about investment time horizons we often focus on only two discrete points – when we invest and when we plan to disinvest. If I make an investment in my pension today, which I hope to draw upon in 30 years’ time; my time horizon is clear**.  Whilst this is an incredibly important element of any investment decision, our tendency is to focus on the start and the end, and neglect what we might do in the intervening period.

What I should have said in response to my friend’s question on the UK is: “it depends on your time horizon…and even if you have a long-term objective, are you going to be checking the valuation and poring over the news every day?  If so, then your time horizon might be a great deal shorter than you think”.

Even if our circumstances do not change, our behaviour can lead to our realised time horizon for any given investment being materially different to what we may have stated at the outset.  The overwhelming driver of this is how we engage with financial markets – how frequently are we checking our portfolio?  How easily can we trade?  How anxious do daily price fluctuations make us? Are we eagerly watching the financial news?  Are we checking on short-term performance?

Making a long-term investment is not simply investing money with the aim of meeting a temporally distant goal; but understanding the behavioural discipline required to be a long-term investor. Where possible the ‘easiest’ route is simply to disengage from the daily cacophony of market and economic news, and commit to a long-term investment plan.  For many^ this is not feasible and in the constant battle between long-term objectives and short-term behavioural pressures there is typically only one winner.  Unfortunately, for most of us, this means that investing for the long-term is simply making a succession of short-term decisions.

* I am making the very simple point that valuation matters to long-term expected returns.

** Of course, circumstances may dictate a change in your time horizon.

^ This is a particular problem for professional investors.