Morningstar Investment Conference: Behavioural Finance by Scott Burns, Director - Global Fund Research, Morningstar
The moment Scott Burns launched into his presentation, he had the audience eating out of his hand. With his finger on the pulse of investor behaviour, he took off with much aplomb: “We are going to talk about all the things our clients do to blow themselves up ultimately.” The audience, consisting predominantly of advisors, gave him their rapt attention.
Skeptics who pondered as to whether the American could comprehend the finicky behaviour of Indian investors were instantly assured: “I am going to show you how stupid Americans are and I am not talking about Congress”.
Citing the example of an American fund, he demonstrated the difference between total return and investor return. The former is a time-weighted calculation that looks at a time period of holding with no additional investments made along the way. Investor return is a money-weighted calculation that takes into consideration aggregate monthly purchases and sales by all of the fund’s investors. The fund boasted a 10-year total return of 15.05% while the 10-year investor return was a pathetic -1.46%.
He validated his point by citing such behaviour in varying degrees across all types of funds. The average US investor-return gap weighted across all asset classes was over 2% which translated into -2% per annum on $12 trillion. Investors flocked when the returns were phenomenal and fled when mean reversion took over. Those still skeptical about a geographic variance in behaviour were silenced when he referred to the “staggering amount of waste” simply as “human nature” since human beings are wired to behave in a particular way irrespective of which part of the globe they reside in. After rightly labeling this as “bad behaviour” Scott pointed to the audience saying “it is your job to stop that from happening”.
He then spent a considerable amount of time helping advisors get more adept at understanding their clients. Here is a gist.
- Having a plan is mandatory but insufficient. One needs to stick to it. If you fail to develop a plan and convince your clients to stick to it, all your learnings are for naught.
- Investors must be taught that all noise is not a signal to act.
- Social resistance is inevitable. Clients will be confronted by friends or colleagues: Why are you rebalancing right now? Why did you buy that? The job of the advisor is to bring the plan to the forefront and ensure that the client takes the right action.
- Never forget that losses hurt, even if your client professes a very high risk tolerance. Investors feel the pain of a loss twice as much as they feel the pleasure of a gain.
- The endowment effect leads investors to believe that they have plenty. We overvalue the good things we already have.
- Most people routinely overestimate their own abilities. This overconfidence is more evident in successful people, the type who come to advisors. Overconfidence causes investors to stick to an investment in a bubble convinced that they will get out before anyone else.
- The recency bias causes us to weigh the most recent data most heavily. Since most of the recency information we have is bad, from the perspective of the global financial crisis, the bias keeps us from taking sufficient risk. It is like the flip of a coin where we give the outcome of the last flip more importance than 10 flips earlier.
- The confirmation bias allows us to readily accept data that plugs in neatly to our personal preconceived biases, and reject data that does not support what we already think.
- Great investors like Warren Buffett, Benjamin Graham and John Bogle have one thing in common – the patience and ability to wait it out. If your risk and time-horizon are not matched by your investments, then you are playing from behind. If your time horizon is longer than the market’s, you may have an edge.
- We are wired to buy high and sell low. If an investor does not leverage the power of averaging, his behaviour will permanently lock in losses.
He concluded by reminding us that we are all in the behaviour modification game. In time, if the investor does not win, we all lose. So keep the faith and ward off bad behaviour.
