Herd mentality is clear to see, yet many hurdles investors face in buying low and selling high are not of their own making, writes Emma Cusworth.
“There is a psychological difficulty dealing with losses. When a 10% loss occurs, doing nothing about it is not a great answer.”
Tim Edwards
It is common knowledge what makes money in the long term: buy low, sell high. Yet, institutional investors face increasing headwinds in their ability to do so. Transparency, regulation, prevailing investment practice and the market environment are all acting to encourage investors to herd into pro-cyclical behaviour patterns in a world that is increasingly sensitive to volatility.
INTO THE PRESSURE POT
With all good intention, there comes the danger of unintended consequences.
Transparency, for example, provides a much clearer picture of the potential risks and rewards investors face, but it also brings with it some less positive traits.
With greater transparency comes greater scrutiny. Because the amount of information available is now so much greater and people are more financially literate, the emphasis on short-term performance is growing. As a result, investors are more easily able to compare performance with a range of internal and external benchmarks, and their peers, all of which adds to the career risk associated with fiduciary management.
The result has been an increasingly short-term view among institutional investors, keen to manage their portfolios in the face of asset and liability volatility, which is more visible to fiduciaries and those they answer to. This makes it increasingly hard to resist the urge to act in the face of change.
“Acting as a result of greater transparency forces higher turnover,” says David Vickers, managing director – multi-assets at Russell Investments, who also believes league-table mentality is alive and well among investors.
“And the investment management industry has embraced clients’ short-termism,” he adds. “Because we are judged monthly or quarterly, the market is generally much more cognisant of short-term performance. Short-term reviews reinforce behavioural biases.”
Many institutional investors, who have the ability to think and act with a long-term view of markets, tend to act in more short-term view than they could otherwise do, according to Tim Edwards, director of index investment strategy at S&P Dow Jones Indices.
“Based on our conversations with those investors, it is also a general truth that many want to be even more short term than they are,” he says. “This is a human behavioural thing more than anything else. There is a psychological difficulty in dealing with losses. When a 10% loss occurs, doing nothing about it is not a great answer.”
Even the regulators are forcing investors to behave in a way that is contrary to their own financial health.
Regulation has unintentionally created profound challenges to investors’ ability to act in a contrarian manner by forcing a much greater focus on liabilities through accounting standards, the increased scrutiny on fiduciary responsibility and the requirement for pension schemes to put funding plans in place. In doing so, they have changed the game for many pension funds.
“Pension funds don’t want big surprises and finance directors don’t want to write big cheques,” says Russell’s Vickers.
As a result, the regulations have had some unintended consequences. “It has changed investors’ behaviour,” says John Finch, director of investment consulting at JLT Employee Benefits. “It has made people think much more about liabilities.”
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