Why some investors have to follow the herd
Analysis: Why do some investors follow the spooked herd in a downturn while others hold their nerve? Rob Stock reports.
In March and April, huge drops on global stock exchanges had many investors, including KiwiSavers, panic-selling shares into a falling market. Businesswoman Julie Rowe, who invests in United States shares through the Hatch online share service, was not among the panicked sellers as the S&P 500 index of leading US companies fell by nearly a third between February 17 and March 16. ‘‘I invested more,’’ she says.
She took the opportunity to profit from continued market falls by putting some money into ‘‘inverse’’ ETFs (exchange-traded funds) that profit when markets are falling, while at the same time retaining her longterm investments.
‘‘I was able to make some money through that,’’ Rowe says.
Researchers around the world have focused efforts on trying to understand what makes some investors panic and rush to sell when markets are plunging, and others hold their nerve.
There’s a lot of money riding on the findings.
Jedrzej Bialkowski, head of department economics and finance at the University of Canterbury, says studies show investors trying to ‘‘time markets’’ lose money by selling shares when prices are low during panics, and reinvesting after recoveries.
‘‘The very simple statistical argument as to why you should resist the panic is market timing is the most difficult thing in investing money,’’ Bialkowski says.
Hatch chief executive Kristen Lunman puts it like this: ‘‘Only around 1 per cent of active traders outperform the market, so just don’t do it, because you probably won’t be in the 1 per cent.’’
When the S&P nosedived, mirrored to a lesser degree by the New Zealand sharemarket, a staggering number of KiwiSavers switched funds, according to the latest KiwiSaver annual report from the Financial Markets Authority.
In total, there were 256,393 fund switches during the year to June, up 54 per cent on the previous year, and much of it happened in March and April.
More than $1.5 billion flowed out of balanced and growth funds into conservative and cash investments, the FMA said.
‘‘In the early days of the Covid-19 lockdown, the contact centres of some providers were clearly stretched, with large volumes of calls from members concerned about the decline in their balances and requests for fund switches,’’ the FMA reported.
More than 33,300 people switched funds twice, double the number seen in 2019, providing circumstantial evidence of attempts at market timing.
Many more, however, held their nerve.
Panic selling by investors is commonly explained as ‘‘herd’’ behaviour, a legacy of humans having evolved to survive in a wild world where predators were bent on making a meal of them.
‘‘If you see a group of people who run away from something, it is natural to join them, and run from it too, and not ask the question of why?’’ Bialkowski says.
The panic-selling of shares has a lot in common with the panic-buying of food and toilet paper as the Covid-19 pandemic emerged – both were attempts by frightened people facing the unknown to achieve safety, Bialkowski says.
But education and experience are both key characteristics of investors who do not succumb to the herd behaviours of fear and greed, he says.
‘‘The key is self-discipline and self-education. The people who have the ability to establish their own view of the market fundamentals are less prone to panicking.’’
People who have observed market panics and recoveries before are also less likely to panic, he says.
Rowe ticks many of the boxes of investors who don’t succumb to panic, and believes it’s because
she takes a longer-term view.
The Commission for Financial Capability says people able to form long-term plans tend to be better managers of money.
But there are other possible contributing factors to Rowe holding her nerve.
Women, studies show, trade less than men, something that has been attributed to males’ irrational confidence in their own abilities.
She has networked with other investors through the Hatch forum. She saw others were holding their nerve, and that encouraged her.
Lunman says that is probably because the service is designed for investors, not traders.
Rowe is also schooled and experienced, having read a lot about investing, and has tried to learn from her own mistakes.
‘‘Every time I have lost money, it has just been from panicking,’’ she says ruefully, acknowledging some sell decisions were against the investment concepts espoused by great investors like US investor Warren Buffet.
‘‘I don’t like to follow rules,’’ she says.
A contrarian nature may also be a strength in an investment crisis, making her leery of cultlike, or herd-like, investor behaviour.
Among the companies she’s invested in are Intel, Virgin Galactic, and Tesla, though she has just sold out of the electric car company.
‘‘It’s just gone nuts,’’ she says. ‘‘I don’t like trends. I don’t like it when everyone’s messaging each other and for no reason are going, ‘Yeah, yeah, buy this one’. It doesn’t make sense.’’
The way Rowe researches companies she is interested in may also contribute to her willingness to go against the herd.
For each dollar she has, she has a binary choice: invest it in her own business, or invest it in one of her investment favourites.
In effect, her company is competing for her own capital with Virgin Galactic and Tesla.
‘‘That’s exactly how I look at it every month,’’ she says.
Intelligence is not in itself a defence against making investment decisions driven by irrational fear and greed, history has demonstrated.
The most famous case of a genius losing money in a speculative bubble remains Sir Isaac Newton, who lost a fortune when the share price of the South Sea Company collapsed in the 1720s.
Newton had at one stage sold his shares in the company, unable to work out why they were priced so highly. But despite his misgivings, he bought back in as its stock price rose and rose, until at one point, it is said, the company was notionally worth more than the combined value of all the land in England.
The great scientist was reputed to have said of his losses, that he ‘‘could calculate the motions of the heavenly stars, but not the madness of people’’.
Investment adviser Jeff Matthews says people who receive advice are better prepared to weather market ‘‘volatility’’.
Matthews, who began his investing career in the immediate aftermath of the 1987 sharemarket crash, thinks people who panic in sharemarket falls often did not understand the risks they had been taking, or how they would feel about losing money.
‘‘It was never properly explained to them how, over the long term, the sharemarket numbers are stacked in your favour, but that you have to live with volatility,’’ he says.
Matthews believes this is especially likely for KiwiSavers, many of whom select funds on the basis of risk questionnaires that are supposed to gauge how much ‘‘volatility’’ they can live with.
Volatility is the investing word for the ups and downs of the prices of individual shares, and the investing rule of thumb is the higher the return an investor is seeking, the more volatility they must live with.
Shares offer potentially higher returns than cash and bonds, but volatility is higher.
Investment advisers like Matthews educate clients to understand the risks and hold their nerve during market drops. He cites one client with an investment portfolio of around $5m at the start of the year – by mid-March it was worth $700,000 less.
Now the market has recovered, his portfolio has topped $5.4m in value.
‘‘Some people are just Nervous Nellies,’’ Matthews says.
It’s an observation that has increasing scientific backing to it, says Lunman, as researchers have now determined that people who are better at controlling their emotions really do make more resilient investors.
‘‘Nervous Nellies’’ need more reassurance during turbulent times. One of Matthews’ clients has investing experience and several million placed elsewhere, but still calls during market downturns asking if it was time to sell everything.
Another thing that Rowe has on her side is a high tolerance for risk. She is young, well-educated, and if she loses money, she has confidence she can earn it back.
‘‘I know I can go and get a job with a corporate in a mid-level to senior role on a salary,’’ she says.
‘‘Or I could go project managing and be a contract manager.’’
And, if all that failed, she’d happily stack shelves at Bunnings.