The challenge of consensus for financial advisers

Most financial advisers have likely been inundated with phone calls in recent weeks as markets took a negative turn following another prosperous year for investors. Loss aversion is one of the most basic human instincts, which makes informed and prudent investing incredibly difficult during periods of change.

This natural instinct is perfectly leveraged by the modern financial media, as the proliferation of free data sources creates a ‘loudest voice’ environment. That is, commentators of all backgrounds, whether managers, media personalities, or analysts, need to be more outlandish and provocative to maintain their readership. 

While transparency and commentary have an important role to play, it makes the job of a financial adviser extremely difficult. Every experienced adviser knows that the most important part of achieving any financial objective is remaining exposed to the market, or ‘time in the market,’ yet this is likely to be more challenging than ever in 2022.

Take for instance the ‘threat’ of higher interest rates and the flood of articles, commentary and statements around the fact that seven interest rate hikes have already been priced-in, or that the Reserve Bank of Australia (RBA) is ‘behind the curve’. In many cases these statements over-simplify what is an incredibly complex environment or alternatively, extrapolate short-term trends into long-term certainties.

Yet a less-informed and less-experienced investor reading the stream of predictions of ‘super bubbles’ and impending market corrections can’t help but be worried. Naturally, they will put this question to their adviser, who is in an exceedingly difficult position. If they say “don’t worry, things will be fine and take no action,” but the market falls, the client will likely lose confidence and say, “I told you so.” Alternatively, if they take action against their own philosophy, they risk doing the opposite.

What this highlights is the challenge of consensus. At present, it appears that every manager is pouring capital into commodities, energy and other ‘cyclical’ sectors as they have historically proven to outperform in rising interest rate environments. But what if this consensus is wrong, and they significantly underperform? For instance, what if the OPEC+ group proceeds with the oil supply increases that were reversed in 2020, and the oil price tanks?

There is somewhat of a stigma for being a ‘contrarian’ in this environment, and while this investment approach (which akin to deep value) hasn’t worked in recent year, it doesn’t make you wrong, it makes you prepared.

Confirmation bias remains the most powerful force shaping investment decisions and not just at the end-investor level, it extends to even the highest-ranking and most experienced investors.

While we are hearing a constant stream of data that confirms the threat of inflation is real and potentially devastating, there is just as many examples of why it is “clearly transitory,” and why we may in fact be facing a period of deflation in central banks act too soon.

If this is the case, and the consensus is wrong, then investors around the world may well be in for some pain ahead. What this suggests is that advisers, more than ever, need to remain as balanced as possible. Portfolios should be prepared for multiple outcomes, and most importantly we must stick to our philosophy, despite pressure to change.

Drew Meredith

Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.