Behavioural Biases in Investing

Chasing Hot Themes

10 January 2016

This is actually a follow-on to our article on the recency illusion.

How many times do we have a certain mandate (for e.g. a conservative investor to invest only in strategies with a Value-at-Risk number below 7%, or the investor who gives up 3 years into a “Growth” strategy to buy into bonds because “Growth” isn’t working out too well) only to switch to something else because we heard of a good idea from a magazine, a friend or the news?

This fallacy of Chasing the Next Hot Theme is a sure-fire way to underperform tremendously and subject the investor to a Style or Risk drift – where the initial investment mandate is not followed but deviated from. Only after suffering a big loss does the investor try to search for what went wrong, only to find to his or her dismay that the current investment strategy is no longer aligned to the original intent.

The diagram below shows the top sector performers in each calendar year, ranked according to returns. You will notice that it is a myriad of colours, for there is no systematic way to allocate to the best performer every year. During bull markets – equity growth does well. During bear markets – cash or fixed income does well. How does one forecast with precision and certainty? It is impossible.

The best way to get a consistent return year in, year out, is to hold a broadly-diversified portfolio (both geographically and by market sector) – which can be seen in the white boxes and dotted red lines. There is less variability. Investors need not forecast and be stressed over whether it will work out or not, and you will be able to sleep better at night.


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GYC Perspectives

Markets are often irrational. Even among experts, forecasting does not consistently work. We instead believe in Evidence-Based Investing (EBI), which uses decades of empirical data and the greatest ideas in financial science to optimise investment outcomes. No market predictions, no forecasts, no emotions. All those things rely on gut-feel and intuition that cannot be consistently replicated.

Here, we share with you the evidence on why EBI works and why forecasting doesn't, as well as articles on topics such as behavioural finance to help you become better investors. New here? You can start with this introduction to EBI. Happy reading!

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