Why the average investor is so bad at it.

Published By StennerZohny Investment Partners+ on July 4th, 2016

 

 

The annual Quantitative Analysis of Investor Behaviour study from financial services consulting firm Dalbar Inc. is a tough read. Not because it’s data-heavy and dry (though it is), but because of its implications.

Every year, the survey looks at U.S. mutual fund inflows and outflows, using these data to calculate the real-life performance experienced by the “average” fund investor over time. It then compares this performance to that of a representative benchmark for a given asset class.

As you can see from the chart, the performance of the average U.S. equity fund investor isn’t anywhere close to the benchmark. That’s not just bad – it’s shockingly bad.

Now, there are good reasons why an individual’s performance might lag the index: Maybe there’s a financial goal an investor has to pay for regardless of market conditions. And of course, fees and transaction costs create a headwind for funds, but not for an index.

Still, these don’t account for the massive performance miss. What does? Behavioural biases. Selling low, buying high; switching to and from funds at the wrong time; chasing “hot sector” performance; unloading core positions to invest in the “fund du jour” – these are actions we take because of hidden prejudices that affect the way we process market information.

Over the past 30 years, I’ve noticed the wealthy tend to be less susceptible to such biases. They tend to be better at recognizing potential biases, as well as controlling the emotions that ultimately lead to them. Here are four examples:

Recency bias

This is the bias that leads us to place a great deal of importance on recent events, and discount or ignore those in the past. We can see this at work when investors pile into and out of positions based on short-term news and current events, without much thought for long-term implications. Case in point: What’s happening right now with the current volatility brought on by the U.K.’s Brexit vote.

Most of the high-net-worth (HNW) investors I’ve met have a keen understanding of market history. Absolutely, they pay attention to what’s going on right now. But rarely do they make that the foundation of their investment decisions.

Confirmation bias

This is the tendency to seek out information that supports our pre-existing opinions, while discounting information that may refute them. Turning again to Brexit, this explains why many investors were caught offguard by the surprise “leave” vote.

Most of the HNW investors I know actively seek out contrary opinions. They do “what if” analyses: what if they’ve gotten it wrong, assumed too much, or overlooked something? Some of them even select members of their advisory team to advocate contrary opinions, to ensure no risk has been overlooked.

Optimism bias

Closely related to the above, this is the tendency to resist information that casts our pre-set beliefs in a negative light. We see this with the reluctance to sell losing positions. Many investors believe that “it will come back,” despite obvious evidence that an investment thesis has changed.

By contrast, HNW investors generally have good selling discipline. No, they don’t like losing money on an idea that didn’t work out. But they don’t let pride or shame get in the way when it comes time to cut their losses.

Social proof

It’s human nature to seek out others who affirm our actions and opinions. And when we see others do something, there’s a natural “pull” to do the same thing. This bias helps explain the “FANGs” (Facebook, Amazon, Netflix and Google – the latter now a subsidiary of Alphabet Inc.) and other hot stocks: The more attention strong stocks get, the more attention they attract from investors who don’t want to miss out.

Most HNW investors I’ve met are natural contrarians. When they learn what the investment crowd is doing, they often want to do the exact opposite. When they identify hot stocks, they want to avoid them – or short them. When they see assets that have been beaten up, they think opportunity. This goes a long way to explaining their consistently superior returns over time.

 

 

Thane Stenner is portfolio manager and director of wealth management of StennerZohny Investment Partners+ within Richardson GMP. He is a founding member and chairman emeritus of TIGER 21 Canada and author ofTrue Wealth. The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinion and estimates constitute the author’s judgement as of the date of this material and are subject to change without notice. We do no warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstance and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard for their own particular circumstances. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. both used under license by Richardson GMP Limited.

Having the family ‘wealth talk’: Four tips to remember

Published By StennerZohny Investment Partners+ on June 22, 2016

 

Let me ask you: How much have you spoken to your kids about wealth? I’m not talking about teaching them savings habits or giving them the occasional investment tip. I’m thinking about a family wealth discussion: how wealthy the family is, how much the kids will inherit, and on what terms.

If you answered, “We haven’t,” you’re not alone. In fact, a recent survey from U.S.-based SEI Private Wealth Management reveals a shocking knowledge gap about family wealth, even among some of the wealthiest families in the world.

Its findings: More than 80 per cent of United States, ultrahigh-net-worth parents (average net worth: more than $18-million) haven’t let their children know how much inheritance they will receive. And only 20 per cent of them had given their kids any training, education or coaching on family wealth matters.

Over the course of my career, I’ve heard plenty of reasons for not having the family wealth talk. Many parents want to have the conversation at some indeterminate time – when the kids “grow up,” for example. Others feel anxious that letting children have a full picture of how wealthy they are will damage the kids’ work ethic. And then there are a few who believe that the subject isn’t really any of their kids’ business.

This can be a significant predictor of future financial disputes within the family. I’ve seen more than a few family wealth “horror stories,” and while no two of them are exactly alike, the common thread is almost always incomplete or ineffective wealth communication.

The fact is, learning how to live with wealth is like learning a new skill: It doesn’t come as soon as you reach a certain age, or when you land your first job, or get married, or buy your first home. It comes through hard work and practice over time. Here’s how parents can make sure their kids acquire that skill.

Find ‘money moments’

Many high-net-worth families I meet don’t have a problem talking to their kids about wealth, but they’re unsure about how or when they should start the conversation. Alternatively, they can feel that such discussions needs to be structured, or planned, in a formal way.

There’s nothing wrong with a structured discussion. But that’s not the way wealth works in our lives. Most of the time, our knowledge of how wealth works (and how it affects our lives) happens in spontaneous moments, as we navigate through life events that touch upon money and personal finance in some way. Learn to make the most of these money moments. For example, a child’s wedding might be a good time to talk about transitioning wealth to the next generation; the birth of a grandchild is an excellent time to discuss wills and estate planning.

Over time, these smaller, in-the-moment, conversations will serve to highlight family wealth values, and open up further conversation.

Dialogue, not monologue

I’ve met many people who treat family wealth discussions as a monologue: The older generation tells other family members what they’re doing, without giving the younger generation an opportunity to voice opinions, express concerns or effect change.

At best, this is a missed opportunity. At worst, it sends a powerfully negative message to your heirs, showing them that their input isn’t valued, and reinforcing old family hierarchies that can so often be the source of friction.

Rather than declaring what your wishes are and assuming everyone will go along with it, try engaging your heirs in a dialogue. Encourage them to ask questions. Listen to their concerns. Get their perspectives. You don’t have to agree on everything, but simply by changing the structure of the conversation, you can go a long way to smoothing out potential conflicts before they happen.

Be open to new ideas

When it comes to transferring wealth from one generation to the other, parents may have a firm view of what they want to accomplish. But that shouldn’t invalidate new ideas from the younger generation. Taking a “my way or the highway” approach when it comes to passing on family assets is almost certainly a recipe for resentment and hostility.

Always remember: The key word in family wealth is “family.” That means being open to improvements and considerations given to other members of the family, and understanding that their ideas may be different from your own.

Play the long game

A lot of families treat wealth communication as a “one-shot deal.” In their minds, talking about wealth is something that happens infrequently – once every several years at most, in which family members come together for a roundtable discussion on a variety of topics, and then largely put the issues aside and get on with life.

Don’t get me wrong: Some conversation is better than no conversation. Still, communicating about family wealth is something that should happen over time. Ideally, the conversation should be organic – something that grows, develops and changes over the years to adapt to changing financial and family circumstances. Like much of wealth management, communication isn’t a sprint, it’s a marathon that requires a disciplined, steady pace to succeed.

 

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinion and estimates constitute the author’s judgement as of the date of this material and are subject to change without notice. We do no warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstance and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard for their own particular circumstances. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. both used under license by Richardson GMP Limited.

What high-net-worth investors are predicting for 2016

Early in 2016, we’re still in the season of annual market forecasts – and the accompanying debate about whether investors should pay any attention to those forecasts, or ignore them altogether.

 

Myself, I’ve always found detailed, precise forecasts of limited value, particularly when they’re published in February after four to six weeks of market performance. Such forecasts are more about improving the odds of being right, and making the analyst/economists look good, rather than communicating insight.

 

I’ve always thought the point of forecasts shouldn’t be to try to pin down the exact number of the S&P 500, or oil, or the Canadian dollar, or housing starts, or whatever else you may be trying to predict. Rather, it’s to identify big-picture themes and issues that may impact your portfolio, so you can take steps to protect yourself.

 

In the 30 years or so that I’ve been working with high-net-worth (HNW) individuals, I’ve noticed this is something they do better than most. Most of them are in the habit of gazing into the future quite often. But they’re less concerned about coming up with an exact number for this or that market/asset/commodity/whatever. Rather, they’re much more concerned about the “36,000-foot view” of what’s going on. This is how HNW individuals consider annual forecasts: as a way of asking “What if …” It’s as much about protecting capital as it is about seizing opportunities.

 

Over the past couple of months, I’ve been speaking to many HNW individuals (both here in Canada, and in the U.S. through the TIGER 21 network) about some of the trends and issues on their radar screens. I’ve also spoken to many colleagues, analysts, portfolio managers, hedge fund managers and other professionals who work with HNW clients. Here is a summary of these expectations, along with my own insight and observations, written as of the last week of December, 2015.

 

Challenging times for Canada

 

Most HNW investors anticipate continued weakness in the Canadian economy. And while opportunities are starting to emerge in the commodities sector (see below), most HNW investors remain cautious about putting too much money to work in Canada. This is a continuation of a trend that started last year, when HNW investors started to pare back Canadian holdings and allocate them elsewhere.

 

When it comes to Canadian real estate, many see an inflated/oversupplied housing market. Most believe (and I agree with them) that we’ll see real estate sour in 2016 – what we’ve seen so far is only the start of a topping process.

 

With consumer household debt to household income rates soaring to all time Canadian records, and the ability of major financial institutions to generate organic growth coming into question, we expect Canadian short-term interest rates will lag U.S. rates. This, of course, will put continued pressure on our loonie; we see it dipping below 69 cents (U.S.), and likely bouncing in and out of that level for most of the year.

 

Continued uncertainty overseas

 

Many HNW investors expect a difficult year ahead in most developed markets, with political/military conflicts creating uncertainty around the globe. We agree with them, and see many international economies unravelling.

 

While many HNW individuals believe the U.S. economy will continue to grow modestly, there is less optimism about the U.S. equity market. We believe the FANGs, for example (Facebook, Amazon, Netflix, Google), will make a major move lower, and this will contribute to a beginning of a U.S. bear market in 2016. Last year, FANGs were the main stocks keeping the S&P 500 afloat, and they likely need to be “ground down” to molars this year.

 

Emerging markets are something of an exception to this gloomy forecast. We expect them to find a bottom in 2016-17. But they will likely experience a very bumpy ride along the way – as they historically always have been. Some HNW investors have started to boost their allocation to emerging markets over the past several weeks, and we expect this to continue. throughout the year.

 

Beaten-down sectors will bottom and start to turn

 

After an annus horribilis for commodity producers, we are preparing for a gradual bottoming in 2016. Some HNW investors have become quite interested in commodities from a deep value perspective. While we’re not in the business of picking a bottom for any commodity (notoriously difficult to do), we have been busy identifying select opportunities, and expect to continue doing so throughout the year.

 

After a brutal 2015, the energy sector certainly has a higher probability of bottoming in 2016, and could start to rise at some point within the year. But it will be a volatile ride and a very slow process. We see U.S. light crude oil reaching lower before it starts its climb back to respectability. One area we’ve become very interested in lately in energy-related master limited partnerships (MLPs). After declining 55 per cent from their peak in 2014 to their early-2016 lows, we are starting to step into this sector within Q1 2016.

 

Gold-related equities hit a bottom in 2015. Deep value bargain hunters have stepped in near current prices. We continue to see value here, particularly in well-managed gold miners. This could be the year that gold finds an interim bottom.

 

Volatility strategies remain top of mind

 

One longer-term trend among HNW investors is the continued attraction of volatility-based strategies – long/short and market neutral funds in particular, and more broadly, the entire alternatives category.

 

We expect continued “smart money” flows into hedging strategies throughout 2016, and in such an environment, we expect active managers to start to outperform passive investments. If the year shapes up largely to what HNW investors expect, the argument for managers who can potentially add alpha in both up and down markets will become very persuasive indeed. We use a combination of both active managers and passive ETFs as optimal in this environment.

 

Most broad markets are still expensive, even after the toughest yearly start in the markets since 1928. However, there are pockets of value emerging, but you have to think and act in a contrarian fashion to benefit.

 

 

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances. Insurance services are offered through Richardson GMP Insurance Services Limited in BC, AB, SK, MB, NWT, ON, QC, NB, NS, PEI and NL. Additional administrative support and policy management are provided by PPI Partners. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.