Unfortunately, as humans, we are poorly neurologically wired to be good investors.
We seem to be hard-wired to promote survival instincts…
Survival instincts such as fight and flight, fear and greed and an aversion to losses – help us to survive but can lead us to bad investment decisions.
For many investors, a propensity to place too much weight on recent events in terms of what the future may look like is quite common. This is known as a ‘recency bias’ and it is this, we regard as the scourge of investors.
Charles Schwab, a major US broker, sponsored some research on its own client base to identify which behavioural biases predominate in their clients and recency bias was the one most commonly exhibited.
Around 50% to 60% of all investors appear to suffer from recency bias, and the number is even higher for younger investors, and I just wonder if this is possibly due to the influence of social media?
Let’s look at an example of recency bias in action.
Some investors may include global commercial property such as shopping malls, offices, industrial buildings, logistics hubs and data centres, in the growth assets portion of their portfolios to provide a bit of diversification to their pure equity exposures.
It is not guaranteed to work all the time but can be beneficial at times. The logic and empirical data certainly support a reasonable case for including global commercial property.
Yet, of late, global commercial property has been under pressure on account of lifestyle and work-pattern changes, driven in part by covid lockdowns.
Add in rapidly rising interest rates and the ‘story’ sounds quite bleak – in 2022, global commercial property, as an asset class was down by around -14%, whilst the UK equity market was up by about +7%.
And, global commercial property is down again in 2023.
Many investors might be tempted to consider abandoning it as an asset class because they believe the future ‘obviously’ looks bleak, and its recent run of poor performance is thus likely to persist.
Yet, doing this would ignore a central tenet of systematic investing that all this doom and gloom is already reflected in market prices for global commercial property – in other words, it might go higher or lower from here, not because of what has recently happened but what new information the market receives.
Every asset class has its bad and good periods yet global commercial property has been the most consistent when compared to Developed and Emerging Market equities over the past 20 years or so!
A rational investor might reasonably want to own all three asset classes in some proportion.
Abandoning or adding to a portfolio simply by extrapolating what has recently done well or badly is not a great strategy and is likely to lead to constant portfolio change, less-well diversified portfolios and poorer outcomes for investors.
In 2022, commodity futures – after many very poor years – were the star asset class, returning around +30% in a year when bonds and equities were down in value. In 2023 they are down in value by around -15%.
And, when gold rises in price, investors are always curious.
As investors, we should never fall into the trap of thinking that the recent past points us to future outcomes.
Furthermore, we should never fall into the trap of thinking that a winning investment strategy is to pick what has just done well and avoid what has just been done badly – following this path is highly likely to result in great disappointment.
In closing, let’s reflect on these wise words written by Charles D. Ellis in his excellent 2002 book Winning the Loser’s Game (Ellis, 2002):
‘The hardest work in investing is not intellectual, it’s emotional. Being rational in an emotional environment is not easy. The hardest work is not figuring out the optimal investment policy; it’s sustaining a long-term focus at market highs or market lows and staying committed to a sound investment policy. Holding on to sound investment policy at market highs and market lows in notoriously hard and important work, particularly when Mr Market always tries to trick you into making changes.’
For more information please get in touch with the Wells Gibson team.