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Anne Unplugged Alexander Forbes Research Institute

Anne Unplugged Alexander Forbes Research Institute. How do our actions as an industry help or hinder investors’ quests for better solutions. Behavioural finance suggests investors make bad investment decisions. But. Consultants and advisers aren’t always helping.

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Anne Unplugged Alexander Forbes Research Institute

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  1. Anne UnpluggedAlexander Forbes Research Institute How do our actions as an industry help or hinder investors’ quests for better solutions

  2. Behavioural finance suggests investors make bad investment decisions. But.... Consultants and advisers aren’t always helping Let’s have a long hard look at what we’re really doing as an industry

  3. Consultants and advisers exist to guide investors away from potentially damaging investment decisions – or to at least guide us to the more prudent decisions. But....

  4. Ours has become an industry dominated by heuristics and the “Law of Small Numbers”

  5. Heuristics – Rules of Thumb • Simplify the message to the client • Make the message easy to remember • Make it easy for anyone to become a “distributor” • Make it easy to have cookie cutter solutions Investors seeking high returns must accept high risk

  6. This is coupled with “The Law of Small Numbers”

  7. An Industry that is dominated by “The Law of Small Numbers” Which is the better fund manager: Quartile performance rankings: • These were all randomly generated performance numbers • Collections of random events do behave in highly regular fashion • The smaller the number – the higher the probability of seeing more extreme events Bias confirmation

  8. Which row of letters were randomly generated? BBBGGG GGGGGG BGBBGB All three were – but our minds refuse to accept this explanation

  9. There are lots of variations on this slide…but you get the gist Source: Grantham, Mayo, van Otterloo 99% confidence levels?

  10. More importantly: • We have allowed our industry to be governed by “The Law of Small Numbers” • Similarly we have cavalierly (as an industry) ignored how much “noise” there is in performance data that clouds what you are really looking at. • Even Warren Buffett’s performance lies within the range of potential outcomes for a purely random distribution of performance outcomes over a 20 year period. (NassimTaleb) • Haugen & Baker paper attacked for only 21 years analysis • But – do investors really have time?

  11. The Unique Challenges of the South African Asset Manager/Adviser/Investor Cult of active management • Easy for fund managers to beat index (?) • Poor quality benchmarks in terms of representativeness • Overall costs may be high but not large differential in fees between active and passive strategies for a strong push to “smart beta” (passive) strategies • Surveys and performance dominate decision-making

  12. What can you tell / What can you not tell - from these performances? What we cannot deduce from this information: Which managers are skilful What manager performances can tell you: • Which asset classes/sectors drove performance? • Asset allocation vs. stock selection ? • Whether the market was providing alpha opportunities and where ? • Which investment styles/philosophies were successful in the environment? • Which strategies were the most volatile? • Which strategies exhibited downside protection in falling markets or maximum leverage of return in rising markets?

  13. The Skill / Luck Continuum and Asset Management • How many factors involved in the path to success? / Source: Michael Mauboussin 2010

  14. Average share Average portfolio Multiple portfolios (2%) (2%) (8%) (30%) Specific Common factors (30%) Market movement Market movement (90%) (98%) Market movement (40%) On understanding return and riskDiwersification – It’s in the nature of the “beast” Beta Beta Source: Barr Rosenberg

  15. Understanding manager performance – the heart of the problem Alpha Beta Contribution is unconditional. Hold a beta of 1.00 and you get 100% of the market movement • Contribution is conditional: • availability in the market • manager skill This exposure you need to meet your long term funding requirement This is just frosting on the cake – can help cover costs

  16. Desperately seeking alpha • Against the ALSI, performance was a function of market structure and not manager skill in 11 out of 12 months. • Against the Swix, market structure (during this period) still accounted for outperformance 50% of the time.

  17. Performance of Active vs. Passive Managers

  18. The Unique Challenges of the South African Trustee/Asset Manager/Consultant Upside-down value chain for the industry • The more you can discern about manager skill, the clearer it becomes that manager selection is essentially a crap shoot • But we seriously end up believing that the greatest value we can offer clients is by being “good investors”

  19. Vicious cycle of mediocrity – with an increasing overlay of external controls from an impatient regulator/governmentIn truth...during times like these our clients need us desperately – we just haven’t listened to what they really needCharles Ellis and the “Winners Game”Not financial advisers...............................financial coaches!

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