Blue Chip Issue 78 - Jan 2021

INVESTOR BEHAVIOUR
risk that Nobel Laureate Daniel Kahneman developed with Amos
Tversky 2 . CPT highlights firstly, the importance of a reference point
for individuals when they make decisions – they hate losses more
than they like gains; and secondly, decision-makers’ inability to
correctly assess probabilities – they overweight extreme outcomes.
Sitkin and Pablo 3 extend this work by proposing that while
investors each have a “risk preference” or character trait of being
attracted or repelled by risk, this preference is mediated by our
“risk perceptions” or assessment of risk in any given situation and
our “risk propensity” to take risk, which is a function of recent
experience in this space. In short, humans are particularly poor
at assessing risks and can easily be fooled by something as
simple as the way a given situation is framed. Investors typically
underestimate risk when experiencing losses and often look for
excess risk at the opportunity of negating
such painful losses. Moreover, our propensity
to assume risk is significantly affected by prior
outcomes (recent successes or failures).
These insights guided our choice of the
explanatory variable for what is a first for
South Africa: a segmentation of South African
investors based on a risk-based analysis of the
switching of their holdings in discretionary
unit trusts. Switches were grouped based
on the relative historical performance of
the funds being switched out of and those
being switched into; the relative risk profiles
of these funds and finally, the average number of switches and
their frequency. The use of the Hierarchical Clustering technique
showed that there are five clearly defined groups (or archetypes)
of switching behaviour inside this large sample of investors:
1) Risk Avoiders. These switches are made by investors who
tend to have a low-risk appetite and rather avoid risk altogether.
They therefore stick to a more conservative asset allocation and
do not switch often. Keeping with avoiding risk and avoiding
change, they are likely to remain in funds with similar (low) risk.
They are relatively likely to chase past performance when current
performance is below inflection. This behaviour seems to be
more common in older investors and slightly more common with
females compared to other archetypes.
2) Contrarians. As the name suggests, these switches are made
by investors who are seemingly showing the opposite behaviour
than that of the other archetypes. They have a seemingly high
risk preference and a high tolerance for downside risk. Whether
performance is high or low, these investors rarely chase past
performance: they are more likely to switch to funds with worse
past performance. Keeping with the title of this archetype, this was
the only cluster which realised a positive behaviour tax.
3) Market Timers. The main driver here is switch frequency since
market timers constantly move between funds in an attempt to
1 “Nixon, P.P., Barnard, M., Bornman, R., and Louw, D.J.D. 2019. The
South African investor behaviour tax and helping investors count
what counts. Momentum Investments.
beat the market and maximise returns. These investors show a mix
of fear and greed driving switches. We see that such behaviour
leads to high behaviour tax during periods of crisis and periods
of fluctuating markets.
4) Anxious. Investors with this type of switching behaviour
seem to have a low risk appetite; however, they do not avoid risk
altogether. These investors are very sensitive to downside risk and
are likely to act out of fear when underperformance looms. They
are very likely to down-risk and chase past performance when
current funds are performing below inflection. Such behaviour led
to high behaviour tax, especially during periods of growth where
they would be “missing out” on performance.
5) Assertives. Investors with this type of switching behaviour are
more risk-tolerant and set on chasing past performance. When
chasing past performance, it is mostly between funds with similar
risk profiles. We expect these investors to be overconfident and
to follow their ways and not be influenced as much by advisors.
The distribution of the occurrence of these switches through time
is presented in the graph (above). As expected, the “Anxious” and
“Risk Avoiders” switches dominate in times of crisis and poor market
returns. The “Market Timer” switches peak after the crisis period.
Why is this segmentation important? A better understanding
of the compromising nature of myopic risk behaviour (which
places too much emphasis on the transient present and its related
emotions) is key to understanding your behaviour, and, if you’re an
advisor, your clients’ behaviour. More importantly,
it can provide a proper basis for intervening at
the right time to avoid the associated negative
implications of these behaviours. Ultimately, the
point is to help all investors avoid the harmful
outcomes of them “being Homer”. These empirical
insights are key to achieving this outcome.
* This article is a summary of a white paper:
“Understanding the great forces that rule the
world. A study on South African investor behaviour”
written by Paul Nixon, Evan Gilbert and Dirk Louw of
Momentum Investments in October 2020.
Professor Evan
Gilbert
2 See Kahneman and Tversky, 1979, and Tversky and Kahneman, 1992.
3 Sitkin, S.B. and Pablo, A.L. 1992. Reconceptualizing the determinants
of risk behavior. Academy Of Management Review, 17(1), pp.9-38.
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