BackMoney Guru | Emotional behaviour impacts your portfolio returns
Money Guru | Emotional behaviour impacts your portfolio returns
PremiumPeter Brooks is a behavioural finance specialist, Barclays
Peter Brooks joined Barclays around five years ago as a behavioural finance specialist. He works with a team of experts to develop and implement commercial applications drawing on behavioural portfolio theory. Barclays has just launched this approach to wealth management in India and Brooks, in an exclusive interview with Mint, explains what this science is all about and how you can smoothen your investment journey by assessing your financial personality accurately and then applying it to the way you invest.
What all does behavioural finance encompass? Is it only investments or does it include the aspect of spending and liabilities too?
The things that fascinate us are how people make their decisions, which are not the decisions they should make. Traditional finance can find out risk and return and build an optimal portfolio, but forgets that to get maximum benefit, you need to hold it for at least five-seven years. What it ignores is that there is daily news; there is hence a daily trade-off between what finance describes as your long-term goals and what your short-term emotional behaviour dictates. That’s where behavioural finance comes in; it tries to address what you can do in the short term to get comfort at night. It looks at everything in terms of client’s financial attitude. It tries to dig into emotional connections that people have and their reactions to events around them.
In the financial personality assessment we do, the risk tolerance rating is similar to what other institutions also do. I would say it’s a bit more sophisticated version. Other than risk, parameters such as composure and market engagement help us determine what we should do to change the implementation and introduce tools in the portfolio to increase that emotional resolve. Composure assesses your propensity to stress and anxiety—low composure means you are nervous and affected by short-term markets and are likely to change long-term strategy on the basis of short-term news. We try to dampen the experience of short-term risk for such people. However, you don’t want to de-risk their entire portfolio as that would go against achieving their long-term goals. So you look for products that will support long-term goals, while taking care of short-term concerns. For example, structured products with some kind of barrier protection.
Do you make the changes when markets turn by redeeming from one product and investing in another or do you make incremental investments in suitable products?
Moving at the point where you are stressed doesn’t work. For example, if you move to structured products when markets are volatile, the option premiums are high and it may cost you more. So it always works better to do the financial personality assessment at the start of the relationship and make product choices accordingly.
But markets are dynamic.
Financial personality assessment has been live in European markets for three-four years and we are fortunate to have seen this through the financial crises. We noticed that people’s behaviour doesn’t change much. If you are assessing somebody’s risk tolerance, you are only assessing the balance between risk and return. Mostly, the risk expectation is very dynamic, whereas return expectation is sticky and the trade-off is static. Composure is generally very stable, so reaction to markets can be ascertained and typically behaviour towards the risk-return trade-off doesn’t change with change in markets.
How do you plan to marry it in with clients’ existing portfolios?
We start with the questionnaire and see if there is anything there which throws light on their recent experiences. For example, you would think that a way for a low composure individual is to have most of the investments in illiquid assets to make it difficult for him to react. But what we find is that people will move anyway, even by paying more to do so. So if you are an anxious client, you should have more liquid assets. Here we can add value by giving other similar insights. We can add to the existing portfolios.
Indian investors chase returns rather than looking for asset allocation and diversification. How will you use behavioural finance in such an environment?
It works beautifully if you are building a long-term portfolio through asset allocation. Even return-chasers, whether they know it or not, are making short-term choices. If you are taking more risks in the short term, you have to be careful not to overload on that risk. The details on the financial personality test show how you can do these things in a smoother way. As a relationship manager, one has to think of ways to ease the client into financial investing.
While this helps in smoothening the process, does it also help in achieving the return expectation set out by the client?
It’s very difficult to prove—the best test is whether you have outperformed yourself. So you test if you did better than you would have done without all these other pieces in place. It’s a hypothetical comparison, but helps investors get through the market with much more resolve. People manage the market dynamics much better.
lisa.b1@livemint.com
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