REALITY CHECK

Your character can determine your fate – even when investing

Reckoning your true propensity for risk versus your realistic expectations is not only a difficult exercise in self-reflection, but the basis for a series of discussions with your private banker, writes PETER GUY

Private bankers will rarely discuss the inescapable truth that your character and behaviour play a major role in your portfolio’s investment performance. Investment mistakes are largely based on poor choices, which is a function of character. And that is one of the most sensitive issues for private-banking relationship managers to discuss with clients. A soured relationship usually means the closure of an account. Bankers say that clients don’t fire banks, they fire relationship managers.

The investment models used to manage your portfolios are mathematically based on efficient markets where perfect information is freely and equally available to all participants and rational, collective investor behaviour. However, if markets were even close to being perfect and random at any given time, then how do these models explain the long period of overpricing (misinformation) before the recent collapse?

Asian investors are more inclined than Westerners to demand some kind of active investment decision-making role trading through their private bankers. Short-term trading or speculation is an inescapable habit of successful Asian businesspeople. Even in the recent volatile and highly uncertain market, private bankers tell me their clients cannot disabuse themselves of short-term imperatives.

It’s almost an innate characteristic of an Asian private-banking client to want to do his or her own investing or trading. Clients are more focussed on return and institutions are more focussed on risk. And that translates into private clients calling up and asking for the day’s best trading idea rather than how to improve diversification and risk levels in their portfolio. These represent vastly different approaches on how to approach investment.

Large private banks can readily serve a client’s desire for financial action

through their sprawling and expensively equipped trading floors. But, private clients are better served if they think with a clearer sense of risk versus return. That allows them to be in a stronger position to understand how their own thinking and investments fit into their portfolio’s long term objectives.

The Greek philosopher Heraclitus held that one’s character determines one’s fate, and it’s certainly true about an individual’s investment decisionmaking outcome. Tremendous risks lurk in today’s markets. Prices can swing wildly in any direction when global markets transform from low-return, high-volatility conditions to the present (potentially) high returns and high losses. Both rational and irrational motives are driving markets.

Understanding your relationship with your wealth – not philosophically, but regarding your long-term objectives – is crucial. Reckoning your true propensity for risk versus your realistic expectations is not only a difficult exercise in self-reflection, but it should also be the basis for a series of discussions with your private banker.

According to private bankers, some clients prefer to make their own decisions (active investing), using their banker to access markets and sort through an enormous group of asset types. Others delegate the management process (discretionary investing) of their portfolio to managers. Whatever method you employ, you should conduct regular reviews of your strategy and performance and stay abreast with regular performance reports. Interact with your private bank’s asset managers and research analysts. An effective investment adviser will offer you highly tailored advice along with a regular stream of investment ideas and research to support your decision-making process.

Private bankers in Asia tolerate their clients’ desire to trade so they will engage them while patiently trying to move them toward longer-term portfolio-management strategies. Over time, most high-net-worth investors eventually realise that their family’s needs require more articulated long-term plans than trading and speculation.

Traditional, quantitative financial theory defines the rational behaviour of investors as seeking to maximise returns. Yet this doesn’t fully capture how investors think during risky periods. Each investor also acts within his or her perception of a comfortable risk level. Fear and greed try to explain all of this behaviour and describe how risk tolerance rises and falls. But risk tolerance and perception is its own illusion as humans are driven and influenced by market sentiment. That explains why it’s easier to invest at the top rather than the bottom of the market. It’s a counterintuitive experience.

Unless the client possesses a professional investment background, he or she will rely on decision-making and mental shortcuts that are comfortable and reduce cognitive dissonance. These tools can turn out to be seriously wrong and delusional, especially when they are based on stereotypes, biases and assumptions that may be incorrect.

Investors have faced the unsettling and risky effects of central-banking intervention in interest rates since 2008. And today, cryptic “black swan” events have returned in force to create new kinds of uncertainty. Investors need to come to grips with their financial behaviour and discern true, long-term strategies that are consistent with their temperance and goals.

The philosopher Heraclitus held that one’s character determines one’s fate