One of the most important roles of a financial adviser is to assist investors in navigating their own ‘behavioural biases.’ The world of behavioural finance was little known until a few years ago, before being made famous by The Undoing Project, Michael Lewis’ biography of Daniel Kahneman and Amos Tversky, two of the founding fathers of the topic.
This isn’t an article about behavioural finance, but rather a look at some of the more common themes occurring in markets today.
The last two years have been an incredible ride, and a potentially career-defining experience for many involved in the finance industry. From all-time highs to a pandemic, to new all-time highs, literally no one could have predicted the events to have occurred in this way. But as the recovery slows and volatility increases in the market, there appears to be a growing prevalence of “recency bias” creeping-in.
Recency bias refers to the unconscious part of our brain that tends to place greater importance on the most recent events that have occurred. A case in point, in my view at least, is with Magellan Financial (ASX:MFG), in which I must disclose I hold shares, currently at a loss.
Magellan is one of Australia’s success stories, with Hamish Douglass a self-made billionaire, depending on the day. The group he started just before the Global Financial Crisis has grown to manage over $100 billion, and is a key part of many investor portfolios.
The share price of Magellan has fallen heavily in recent months, no doubt for a multitude of reasons, which I don’t intend to focus on here, but significant attention is being paid to its global fund’s “underperformance.” While I don’t invest into or recommend this fund, I thought it was worth taking a closer look.
According to recent reports, Magellan’s Global Fund is now under-performing over one-, three- and five-year periods, sparking inevitable suggestions in the marketplace that sustained under-performance may lead to increasing redemptions. While the fund has clearly underperformed over this period, the driver has actually been only a short-term one.
Looking back before the pandemic, at the December 2019 performance update, the global fund was outperforming over every period since inception, i.e., one, three, five, seven and ten years, while also capturing less than 50 per cent of the downside in markets. The story was similar most of the time during the pandemic, until the vaccines hit.
Douglass misread the value recovery, something he has highlighted previously, but did so based on the lack of clarity and perceived lower-quality investments and a preference to continue protecting investors’ capital. So effectively, around one year of under-performance, due to a more conservative approach, has sullied more than five years of positive outcomes.
Where recency bias comes in, is in the growing popularity of strategies that have achieved the opposite. With such a powerful and sustained bull market, anyone going ‘long’ technology, commodities or just about anything in equity markets, has seen superlative returns. So much so that there are now many strategies that, after underperforming for many years in the past, have seen one year of outperformance turn the tables.
The big question for both sides of this coin, is which is better-positioned to deliver consistent, repeatable returns to investors as the circumstances continue to change.