Transcript Are Investors Rational and Does it really matter?

Are we building portfolios for investors
or for fund managers?
Behavioural Finance Implications in
Superannuation Investing.
University of New South Wales
John Livanas
Central Concept
Assess correlation of
investment decisions
with age, gender,
market
4,000
Investment
Switches
100,000
Super
Investors
202 First
Time
Investment
Switches
Assess impact of first
time choice
236
Survey
Data
Establish Utility
Standardised Risk Return Concepts
• Consistent Method of assigning values to
‘Riskiness’ for quantitative analysis
Relative Risk
‘Value’
Portfolio Names
Typical Assets held
‘High Growth’
85-90% Equities, Property
1
75% - 85% Equities, Property
0
65-70% Equities, Property
-1
45-55% Equities, Property, with the
remainder in Bonds, Cash
-2
‘Capital Guarded’
<15% Equities, Property, with the
remainder in Bonds, Cash
-3
‘Cash’
Largely Cash with possibly some
short-dated Bonds
-4
‘Trustee Selection’
‘Diversified’
‘Balanced’
Risk Shifts and Market (after notional carry-costs)
Unit Price Adjusted for a Carry Cost of 5.5% compounded weekly
0.6000
$4,000,000
Unit Price less Carry Costs
Money Weighted Risk Weighted
$3,000,000
LHS
0.4000
Adjusted Unit Price Index
$2,000,000
0.2000
$1,000,000
0.0000
$0
RHS
-$1,000,000
-0.2000
Period
-0.4000
Ave. Money
Weighted
Risk Shift
Ave. Risk
Shift
-$2,000,000
Pre 1/3/2005
1.869
$37,763
Post 1/3/2005
1.922
$64,693
-$3,000,000
1/03/06
1/01/06
1/11/05
1/09/05
1/07/05
1/05/05
1/03/05
1/01/05
1/11/04
1/09/04
1/07/04
1/05/04
1/03/04
1/01/04
1/11/03
1/09/03
1/07/03
1/05/03
1/03/03
1/01/03
1/11/02
1/09/02
-$4,000,000
1/07/02
-0.6000
Investors seem to take the lead from the market – believing that the market
trend itself provides information
Correlation of First-Time Risk Shifts and Age
Stratified Correlation of Age with Risk Profile
1
Median Age of Segment
0
40
45
50
55
Risk Change
-1
R2 = 0.7164
-2
-3
Age versus Risk Profile
-4
Linear (Age versus Risk Profile)
-5
Events seem to trigger ‘Rational’ Behaviour
60
65
Utility Curves for Return
1.50
Utility Curves for Return
1.00
Relative Utility
0.50
0.00
-0.50
All
Log. (All)
-1.00
Linear (All)
-1.50
3.5%
4.0%
4.5%
5.0%
5.5%
6.0%
6.5%
Return p.a.
7.0%
7.5%
y = 2.6296Ln(x) + 7.2311
R2 = 0.9721
y = 44.675x - 2.953
R2 = 0.9459
8.0%
8.5%
9.0%
Utility Curves for Risk
1.50
Utility Curves for Risk
1.00
All
Linear (All)
Relative Utility
0.50
Poly. (All)
y = -7.513x + 1.3674
2
R = 0.9959
y = 3.2612x2 - 8.5644x + 1.4098
R2 = 0.9981
0.00
-0.50
-1.00
-1.50
0.0%
10.0%
20.0%
30.0%
Probability of an annualised negative return over the time horizon
40.0%
Utility Curves for Time Horizon
1.50
Utility Curves for Time Horizon
1.00
Relative Utility
0.50
0.00
-0.50
All
Linear (All)
-1.00
Log. (All)
y = -0.0196x + 0.0929
2
R = 0.2704
y = -0.0407Ln(x) + 0.051
R2 = 0.0738
-1.50
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
Number of years to wait until the investor has some certainty that the return targets will be met
10.0
Quantifying the utilities
E(R)
pE(R)
E(Z)
pE(Z)
E(T)
pE(H)
3.9%
-1.352
no chance
1.425
1 year
-0.008
6.0 - 6.3%
0.121
13% chance
0.295
3 year
0.009
6.5 - 7.2%
0.083
20% chance
-0.153
5 year
0.177
7.2 - 8.1%
0.375
25% chance
-0.479
10 year
-0.178
8.0 - 9.0%
0.774
33% chance
-1.087
Consequently, for the state s=1, for all C’s =1, (5) solves as: 0.375-1.087-0,008 = -1.013
Adding the Partial Utilities
Partial Utilities 1.425
of Risk
0
0.295
13%
-0.153 -0.479 -1.087
20%
25%
33%
Partial Utilities
of Return
-1.352
3.90%
0.07
-1.06
-1.51
-1.83
-2.44
0.121
6.15%
1.55
0.42
-0.03
-0.36
-0.97
0.083
6.85%
1.51
0.38
-0.07
-0.40
-1.00
0.375
7.65%
1.80
0.67
0.22
-0.10
-0.71
0.774
8.50%
2.20
1.07
0.62
0.29
-0.31
Risk Return isoutilities
2.00-2.50
1.50-2.00
1.00-1.50
0.50-1.00
0.00-0.50
-0.50-0.00
-1.00--0.50
-1.50--1.00
-2.00--1.50
-2.50--2.00
2.50
2.00
1.50
1.00
0.50
0.00
-0.50
-1.00
-1.50
8.0 - 9.0%
-2.00
7.2 - 8.1%
-2.50
6.5 - 7.2%
no chance
13%
chance
6.0 - 6.3%
20%
chance
25%
chance
3.9%
33%
chance
Risk Return Isoutilities as a plane
High
8.0% 9.0%
Indifference
1
Curves
2
3
2.00-3.00
1.00-2.00
6.5% -
Optimal
Portfolio
0.00-1.00
-1.00-0.00
-2.00--1.00
-3.00--2.00
Efficient
Frontier
6.0% -
Low
Expected Return
7.2% - 8.1%
3.9
no chance
Low
13% chance
20% chance
25% chance
Standard Deviation
33% chance
High