Behavioural Biases: Edition 1 - Anchoring
by James Twidale
The years I have spent creating investment solutions for investors has led me to have the privilege of dealing with many different clients and advisors. The spectrum of investor or investor proxies have given me much to think about. Its very tough to see investors and advisors make decisions that negatively impact their investment outcomes, however it’s not because these investors or advisors are acting out of desire to sabotage their outcomes.
The decisions they are making are hardwired into their behavior as a result of thousands of years of evolution and survival instincts that are pre-programmed into our brains and through the education or training given to them in their schooling and learning processes. They are behaving in a way that they deem completely rational, yet the result is the opposite when looked at over time.
These are called behavioural biases and are going to the be subject of the next few newsletter editorial pieces.
Instead of focusing on current affairs and market related matters, I find that those topics only further serve to create the incentives for investors/advisors to fall into these rationale “traps.” I thought it would rather be better to spend some time highlighting the common behavioral biases that we are plagued by.
At this point its very valid to point out that investment managers, fund managers and specialists are no better at avoiding these biases than anyone else in general. We tend to be even more susceptible to a few of them, which will make sense in future editions of these editorial pieces.
This abovementioned subject is now recognized amongst investment academia and receives far more focus in investment decision making and solution creation. Which is good for all investors and clients but the outcomes are not perfected yet and therefore the onus to avoid our own pitfalls falls to all reading this edition.
Ignorance is not bliss in this scenario and the more aware of these biases we all are, the better off we become at avoiding them, or at least reducing the frequency with which we fall into them. So, this series hopes to enlighten you of the risks that you face when acting in relation to investments.
To start the series off, we will be focusing on anchoring.
Anchoring is something we all do in everyday life but is potentially harmful when it comes to investment decision making. It is not incredibly complicated and the term ‘anchoring’, unlike some of the other behavioral traits is intuitive. Anchoring, when it comes to investing, refers to an individual (in this case an investor, advisor or investment manager) relying too heavily on an initial piece of information (or pre-existing information) when making subsequent decisions. Below 3 examples to try illustrating anchoring as a behavioural bias:
Example 1: An example of anchoring is where you purchase a share in a company for say R100. If the price were to drop to R80 subsequent to the original purchase, the investor will be more likely to hold onto the investment until it at the very least retraces and surpasses the R100 original purchase price. Even though latest information may have become available which makes the R80 valuation a fair reflection of the true value of the investment. This could also be despite the fact that the investor may have overvalued the investment at the time of original purchase (due to incorrect information being used at that point in time) Regardless, the investor will anchor to the R100 valuation because at the time of purchase the investor assumes that R100 was a rational valuation for that share.
Example 2: Anchoring is especially prevalent in the currency space, as determining the fair value of currencies is incredibly complex. If an investor where to purchase USD at an exchange rate of R12/$ and six months later the price of USD was R15/$, the investor would probably conclude that the original decision was vindicated but that secondly before purchasing more USD, it would be more prudent to wait for the price of the USD to get closer to the original price of R12/$. In this case the investor may wait forever because the fundamentals have changed such that the new fair value of the USD exceeds R12/$ and therefore if waiting for a pull back to the investors perceived fair value, the wait may be one that negatively impacts the long-term investment objective.
Example 3: An even more practical example is when you buy your house. The price you pay is likely the lowest you would ever be willing to sell it for, because there is no way you would have overpaid for your house. So even if there is a housing market crisis, economic crash, re-zoning of the area, increase in interest rates, or any of a plethora of possible negative price factors there is no way your house could ever be worth less than the seemingly massive price you originally paid! Right?
The impacts of anchoring include holding overvalued investments for too long, selling undervalued investments too early or holding investments that have “lost” value relative to their original price despite information having changed.
The only way to avoid this is to ensure when making an investment decision you understand the environment in which you are making the decision and have gathered all the revised and relevant information, such that you are able to make an informed decision.
We all are guilty of falling into this trap of anchoring and that’s ok, we are all human after all. Going forward should be a little different in the future with some light shed on this type of behavioural bias. As with this knowledge, you can challenge your thinking whenever you review your desire to make an investment decision with your advisor.
Market Update - May 2019
by Oratile Tlhabane
Equity markets across the globe experienced a decline as the US-China trade war intensified. The ALSI saw a reversal of fortunes with a 4.8% loss for the month of May, led by a 6.0% drop in Industrials. Sasol, which announced further ballooning costs of its Lake Charles project in the US, saw a sharp sell-off. The project would now cost at least 50% more than the initial estimate, leading to the companies share dropping 22.7%, the most in just over 20 years.
Resources ended the month 5.1% lower, while Financials dropped 2.3% with companies from both sectors announcing sales of assets or the closure of physical branches. SA Property closed 0.9% lower for the month while Bonds added 0.6%. The below graph shows the Asset Class returns for the month of May, in ZAR terms:
May Asset Class Returns (ZAR)
Breaking down the market according to market capitalization sees Large Caps dropping 5.1%, while Mid and Small Caps fell 3.5% and 2.7% respectively. The decline in share prices was further exacerbated by foreign investors selling out of SA stocks due to index compiler MSCI Inc. making changes to the Emerging Market (EM) index. Net outflows of R13.3 billion were the largest flows since SA was included into the index. EM experienced a 7.2% contraction for the month of May.
Global markets were not immune to the risk-off sentiment, as global equities closed the month 5.8% lower. Developed markets shed 5.8% on the back of heightened geopolitical risks. Adding to the 25% tariff imposed on Chinese goods, President Trump has threatened to impose new tariffs on all Mexican imports, citing illegal immigrations as the catalyst. An updated agreement has however been reached, subsequent to the tariff talks.
The European elections saw the rise of populist factions receiving a sizeable number of seats in the EU parliament. Albeit nationalist in nature, the Rand depreciated 1.0% against the Euro. Prime Minister There May’s resignation saw the Rand strengthen 1.8% against the British Pound.
With investors selling equities in the month of May, due to heightened trade tensions and downwardly revised economic outlooks, assets that are classified as ‘safe-assets’ benefited from the outflows, albeit disproportionately. Global Bonds advanced 1.4% while Gold rose 1.8%, which is likely to continue with the US Federal Reserve signaling potential interest rate cuts this year.