Speaking at the Federation of European Independent Financial Advisers’ Spring Conference 2015, David Itzkovits, head of investments at Sanlam Global Investment Solutions, said the average investor’s returns fall below the S&P 500 index every year by a significant amount due to their fund manager’s positive and negative emotions.
“People love to think that the investment process is divorced from emotion, but in reality it is not at all,” he said. “Let’s say you buy an Apple stock, for example, every time you hear someone say they are buying an Iphone you can picture your stock rising.
“We take the simplest and easiest process to get results. This simplifies life, but can lead to error by way of cognitive bias, wherein information that would allow a more rational decision is habitually disregarded.”
A marriage of emotion and rationality
He said the most common errors are: loss aversion, in which certain gains are favoured over a higher outcome which features a chance of loss; the prospect theory, where losses are felt at a higher intensity than gains; overconfidence, or, the belief that higher returns can be made from more frequent trades; and herding, where multiple managers follow the same trend.
“The solution to this problem is to marry classical, pragmatic, investing with behavioural investing,” he added.
He said Sanlam’s P2strategies Global Fund minimises the impact of major market drawdowns and actively reduces portfolio volatility by utilising a “systematic investment process” which “avoids strategies that rely on human discretion and emotion”.
“P2strategies uses a systematic investment process which is driven by a mathematical rule based program,” added Sanlam. “The systematic nature of the process removes emotions from investment decision making.”
The Dublin-domiciled fund combines targeted volatility and capital protection to actively produce buy or sell orders on an intra-daily basis.
“As markets fall, the strategy will reduce an investor’s equity exposure, thus minimising the impact of major market drawdowns. In rising market, P2strategies provides more equity exposure,” the company said.
“Small positive or negative market movements don’t alter equity exposure significantly. Adjusting for small movements could limit upside potential. An investor may see high participation in minor losses, but participation will still be high if the market bounces back.”