Rotman Management Magazine - - CONTENT - Lisa Kramer

In your re­search, you have found that in­vestor risk ap­petites vary by sea­son. How so?

As day­light be­comes less abun­dant in the fall and win­ter months, our moods re­spond ac­cord­ingly. Many peo­ple can iden­tify with the no­tion of ‘win­ter blues’; but at a more clin­i­cal level, psy­chol­o­gists have iden­ti­fied a con­di­tion called Sea­sonal Af­fec­tive Dis­or­der (SAD), which causes se­vere de­pres­sion in a sig­nif­i­cant part of the pop­u­la­tion.

Early in my ca­reer, I was in­trigued by the pos­si­ble im­pli­ca­tions of this dis­or­der on fi­nan­cial de­ci­sion mak­ing. Find­ings from Psy­chol­ogy had long shown that when peo­ple are in a neg­a­tive mood, they be­come more risk averse, and com­bined with my fi­nance per­spec­tive, this all seemed to be part of the same big pic­ture. My col­leagues and I were able to show that, as day­light di­min­ishes, peo­ple shun riskier as­sets like stocks; and when it be­comes more plen­ti­ful, in the spring, they jump back into these hold­ings. In short, our moods and pref­er­ences vary sea­son­ally, and this spills over into our fi­nan­cial de­ci­sion mak­ing.

How preva­lent is this ef­fect?

Roughly 10 per cent of the global pop­u­la­tion suf­fers from se­vere SAD, but this varies by lat­i­tude. Peo­ple who live in trop­i­cal zones are less likely to be af­fected than those who live, for in­stance, in parts of Scan­di­navia — some of which get only six hours of sun­light per day in late De­cem­ber.

My for­mer Rot­man col­league Mark We­ber and I con­ducted a sur­vey of fac­ulty and staff at a large North Amer­i­can univer­sity, and we found sim­i­lar re­sults. What sur­prised us was that the other 90 per cent or so of our sam­ple also ex­pe­ri­enced sig­nif­i­cant vari­a­tion in mood across the sea­sons — but less se­verely. It turns out that most of us be­come more de­spon­dent in the darker sea­sons of the year; but a frac­tion of us be­come so de­pressed that we need med­i­cal help.

In one re­cent study, you looked at how mu­tual fund hold­ings are af­fected by these sea­sonal fac­tors. Tell us what you found.

We con­sid­ered how much money in­vestors put into and take out of their mu­tual funds in var­i­ous months, and again, we found strong ev­i­dence that sea­son­al­ity is a key fac­tor.

In the fall, when peo­ple are be­com­ing some­what more de­pressed and risk averse, we found a much lower ap­petite for risky cat­e­gories like stock-based mu­tual funds, and a much greater ap­petite for ‘safe’ cat­e­gories, like gov­ern­ment bond funds. Then, six months later — as spring blooms and risk ap­petite re­turns — these flows switch in the op­po­site di­rec­tion.

Our find­ings are sta­tis­ti­cally sig­nif­i­cant: We ex­am­ined tril­lions of dol­lars’ worth of U.S. mu­tual funds for this study and iden­ti­fied sea­sonal flow dif­fer­ences due to mood in the tens of bil­lions of dol­lars. We also con­sid­ered mu­tual fund flows for Canada, and found sim­i­lar re­sults — al­beit on a smaller scale, on par with the smaller size of our econ­omy.

What is the broader eco­nomic im­pact of your work?

First, it pro­vides fur­ther ev­i­dence that our mood in­flu­ences the way we make de­ci­sions. As a re­sult, at a pol­icy level, when reg­u­la­tors are de­cid­ing if or how to in­ter­vene in fi­nan­cial mar­kets — say, dur­ing a fi­nan­cial cri­sis — it would be sen­si­ble for them to take into ac­count the time of year. If it is au­tumn, and mar­kets are crash­ing (and per­haps not sur­pris­ingly, mar­kets do tend to crash more fre­quently in the fall), we know that peo­ple might re­act more dras­ti­cally than if that same event hap­pens in the spring. It is pos­si­ble to de­sign in­ter­ven­tions and reg­u­la­tory re­sponses, de­pend­ing on sea­sons. That’s the key im­pli­ca­tion of my work.

Lots of other re­lated be­havioural find­ings are com­ing out, with broad so­ci­etal im­pact. One study I read re­cently looked at mood as it is in­flu­enced by the amount of sleep peo­ple get, and how that pans out in elec­tion re­sults. In a par­tic­u­lar time zone, for in­stance, re­searchers found that the peo­ple who lived fur­ther east got less sleep that those who lived fur­ther west, and that this led to sys­tem­atic dif­fer­ences in the way they voted on elec­tion day. As that pa­per sug­gests, can­di­dates might want to widely dis­trib­ute cof­fee on the morn­ing of an elec­tion!

Another re­lated find­ing is that when the weather is bad on elec­tion day, peo­ple make more risk-averse choices at the bal­lot box. So if it’s pour­ing rain, they are less likely to vote for can­di­dates that are per­ceived as ‘risky’. This is broadly con­sis­tent with what we’ve found in fi­nan­cial mar­kets.

As day­light di­min­ishes, peo­ple shun risky as­sets and in the spring, they jump back into riskier hold­ings.

Tell us about your find­ings in Aus­tralia and other coun­tries.

I men­tioned ear­lier that flows into and out of risky mu­tual fund cat­e­gories vary by sea­son in places like Canada and the U.S.; but this ef­fect ba­si­cally flips in the south­ern hemi­sphere, be­cause when it’s fall up here, it’s spring in, say, Aus­tralia. Ba­si­cally, wher­ever it hap­pens to be fall, that’s when peo­ple gen­er­ally be­come more risk averse.

This find­ing was cor­rob­o­rat­ing ev­i­dence for our no­tion that the sea­sons are at work be­hind this ef­fect. Ad­di­tion­ally, when we study stock mar­ket re­turns around the world, we ba­si­cally find that peo­ple avoid cer­tain stocks in the darker months, and this ef­fect is stronger the more north­ern the coun­try you con­sider. So, if you com­pare the U.S. with Canada, and then with Bri­tain, and then Swe­den, the sea­son­al­ity in stock re­turns only gets stronger. And when we looked at coun­tries like Aus­tralia, New Zealand and South Africa, this sea­son­al­ity was ex­actly out of sync by six months. Our ev­i­dence is con­sis­tent across a broad range of coun­tries.

How can the av­er­age in­vestor in­cor­po­rate these find­ings in or­der to op­ti­mize her port­fo­lio?

The im­pulse might be to take what I’ve just de­scribed and try to trans­late it into some sort of ‘mar­ket-tim­ing strat­egy’: but that is the ex­act op­po­site of what I rec­om­mend. The trick is not to try to time the mar­kets — be­cause in any given year, the ef­fects we’re talk­ing about can be com­pletely swamped by larger eco­nomic fac­tors that are fun­da­men­tal in de­ter­min­ing the dy­nam­ics of re­turns.

My ad­vice would be to avoid mar­ket tim­ing al­to­gether, be­cause the re­search shows that peo­ple who at­tempt to time mar­kets per­form worse, on av­er­age, than those who just buy and hold. It is a much bet­ter idea to stick with longer-term in­vest­ing prin­ci­ples — to have a well thought-out for­mula for a long-range in­vest­ing plan, for ex­am­ple, and to avoid buy­ing or sell­ing on im­pulse when things hap­pen sud­denly in mar­kets.

Fur­ther­more, if things are topsy turvy in your life, that is the wrong time to be mak­ing any kind of im­por­tant fi­nan­cial de­ci­sion. If you don’t feel con­fi­dent about man­ag­ing your emo­tions in the con­text of in­vest­ing, one course of ac­tion can be to con­sider hir­ing an in­ter­me­di­ary. There are a cou­ple

of op­tions on that front. One is to elicit the as­sis­tance of a fee-based fi­nan­cial ad­vi­sor, to pro­vide ad­vice that is tai­lored to your spe­cific sit­u­a­tion, and isn’t in­flu­enced by com­mis­sions that more tra­di­tional ad­vi­sors rely on.

Another op­tion is the idea of a ‘robo ad­vi­sor’ — a class of fi­nan­cial ad­vi­sor that pro­vides fi­nan­cial ad­vice or port­fo­lio man­age­ment on­line with min­i­mal hu­man in­ter­ven­tion, based in part on al­go­rithms. This rel­a­tively new class of in­ter­me­di­ary of­fers an ar­ray of port­fo­lios that are cus­tom­ized to in­vestors’ char­ac­ter­is­tics, such as age, risk pref­er­ence, and so on. Fees for robo ad­vi­sors are lower than mu­tual funds fees, es­pe­cially in Canada, and the de­gree of cus­tomiza­tion they of­fer is higher than an in­vestor would get with an ex­change-traded fund or a mu­tual fund.

For peo­ple who want to take a more hands-on ap­proach, another op­tion can be to hold an as­sort­ment of ex­change­traded funds rather than mu­tual funds. But then, you have to re­ally be dis­ci­plined about try­ing to over­come those emo­tional urges when mar­kets are choppy, or if your per­sonal cir­cum­stances are anx­i­ety-pro­vok­ing.

What are the key take­aways for peo­ple work­ing in an in­creas­ingly global in­vest­ment land­scape?

Our be­liefs are largely a by-prod­uct of the en­vi­ron­ment in which we grow up, and in an in­creas­ingly global land­scape — in­vest­ment and oth­er­wise — we are in­ter­act­ing more and more with peo­ple who were brought up un­der very dif­fer­ent con­di­tions. Cul­ture and be­liefs are largely in­her­ited, so when peo­ple move to a dif­fer­ent ge­o­graphic re­gion, they of­ten bring with them in­grained regional and cul­tural bi­ases and be­liefs.

In parts of Italy, for ex­am­ple, the level of trust in in­sti­tu­tions—in­clud­ing fi­nan­cial in­sti­tu­tions — is very low, and in these re­gions, stock mar­ket par­tic­i­pa­tion is also very low. If, for cul­tural rea­sons, cer­tain peo­ple aren’t par­tic­i­pat­ing in stock mar­kets, that can have con­se­quen­tial spillover ef­fects, in­clud­ing re­tire­ment pre­pared­ness and the eco­nomic growth prospects for an en­tire re­gion.

As we be­come even more glob­al­ized, we need to be aware that ev­ery in­di­vid­ual is a bi­o­log­i­cal be­ing with count­less be­havioural bi­ases. We also have to be aware of this as we’re in­ter­act­ing with peo­ple who might have very dif­fer­ent bi­ases from us. In gen­eral, when we are de­sign­ing the way we in­ter­act with each other — in­clud­ing de­ci­sion mak­ing in our fi­nan­cial in­sti­tu­tions — we need to be in­creas­ingly aware of the in­flu­ence of cul­ture and the en­vi­ron­ment.

Cul­ture and be­liefs are largely in­her­ited, so when peo­ple move to a dif­fer­ent re­gion, they bring with them in­grained bi­ases and be­liefs.

Lisa Kramer is a Pro­fes­sor of Fi­nance in the Depart­ment of Man­age­ment, Univer­sity of Toronto Mis­sis­sauga and a Re­search Fel­low of Be­havioural Eco­nomics in Ac­tion at Rot­man (BEAR). Her re­cent pa­per, “Sea­sonal As­set Al­lo­ca­tion: Ev­i­dence from Mu­tual Fund Flows,” with M. Kam­stra, M. Levi, and R. Wer­m­ers, was pub­lished in the Jour­nal of

Fi­nan­cial and Quan­ti­ta­tive Anal­y­sis and can be down­loaded on­line. Her 2012 pa­per, “This is Your Port­fo­lio on Win­ter,” can also be down­loaded on­line. Rot­man fac­ulty re­search is ranked #3 in the world by the Fi­nan­cial Times.

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