Australia’s first independently rated peer to peer offering
La Trobe Financial is pleased to announce that the Select Mortgages Option, a peer-to-peer (P2P) investment option in the La Trobe Australian Credit Fund has been recognised with a “Superior 4 Star” rating by SQM Research. This is the first independent rating of a peer-to-peer offering in Australia.
In the rating report, SQM Research Head, Louis Christopher states “the Fund has outperformed the peer group and SQM Research’s comparative benchmark on both a one-year, three-year and since inception ....... the Fund’s three-year rolling return was 8.4%, compared to the benchmark’s and peer group's 5.6% and 7.6% respectively”.
Further Christopher says “SQM Research believes that the highly resourced and skilled team in place at La Trobe Financial Group, the Fund’s track record, in particular during the GFC, as well as La Trobe Financial Group’s financial and historical strength in the Lite-documentation space should allow the Fund to continue to provide investors with strong risk-adjusted returns.”
This is a first for Australia’s P2P sector. P2P investment allows individual investors and advisers to choose individual loans that suit their own risk/return profile. This form of investment has become increasingly popular given its ability to allow the creation of individual tailored sub-portfolios on an individual investor basis.
Click here to read the SQM Research report.
How behavioural finance can help you
“To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.” - Warren E Buffett
Preface to the Fourth Edition of “The Intelligent Investor”, by Benjamin Graham
Recently, we’ve been talking to many investors and advisers who are finding it very difficult to get clear investment signals from world markets. Last April, the S&P/ASX 200 index was touching on 6,000 and looking strong. As we write this newsletter, just one year later, the same index has slumped to below 5,000.
Source: Yahoo7 Finance
Much has been written of the multitude of threats and uncertainties confronting investors. Demographic pressures, asset value distortion in the wake of unconventional monetary policy and public and private debt are just some of the highly complex and topical issues that have the potential to affect investment outcomes into the future.
So what is an investor to do? How can one individual – frequently with a busy work, family and social schedule of his or her own – hope to master all the disciplines and topics required to make informed decisions about the likely impact of such complex economic drivers?
The answer, at least according to such luminaries as Warren Buffett, is that the individual does not even need such mastery. Investment success is driven less by intellect and esoteric knowledge and more by the emotional discipline of the investor in adhering to a sound investment framework.
At its simplest, this insight is nothing new. “Know thyself” was carved into Apollo’s temple at Delphi in ancient Greece. But whilst no one would disagree with the principle, history shows that it is remarkably difficult for investors to put it into action in a way that positively affects portfolio outcomes. Research by Dalbar and Blackrock in 2012 indicated that the average retail investor underperformed every major asset class over the twenty year period from 1992 to the end of 2011. They even underperformed inflation!
The obvious explanation of this poor investment performance is emotional or behavioural factors. After all, if these investors had simply invested in a portfolio of stocks broadly representative of the index, their returns would have been more than 370% higher!
A relatively new, but fast-growing area of research is attempting to address these emotional or behavioural factors and their effects on portfolio returns. ‘Behavioural finance’ starts with the premise that the theories that have traditionally been used to predict market performance are flawed. These theories, such as the efficient market hypothesis and the capital asset pricing model, assume that people for the most part behave rationally and predictably to maximise their economic self-interest.
Behavioural finance points out that this assumption does not reflect how people behave in the real world. A hard-headed economic rationalist, for example, would never purchase a lottery ticket. What’s more, there are a range of empirically observed market patterns that defy easy explanation under traditional theories, such as the January Effect, the Winner’s Curse and the Equity Premium Puzzle.
To explain these “irrational” phenomena, behavioural finance theory has identified a number of patterns of thinking (or ‘cognitive biases’) that negatively affect the performance of investors’ portfolios. The intelligent investor realises that the first step to avoiding investment mistakes based on these biases is to understand the biases and how they work.
Bias 1: Anchoring
Anchoring: Investors, like people everywhere, have been observed to ‘anchor’ their thinking too heavily around the first piece of information offered. Once the anchor is set, it is used to interpret other information. This can have a significant effect on the ultimate decision, even if the anchor is absurd or irrelevant. In one interesting psychological study, two groups of people were asked to guess the age of Mahatma Gandhi at the age of his death. The first group were asked whether it was before or after age 9, the second whether it was before or after age 140.
Clearly, the two ‘anchors’ were so far wrong as to be irrelevant. But the simple fact that they had been mentioned significantly affected the participants’ responses. Those in the first group guessed an average age at death of 50 years. The second group’s responses gave an average age of 67 years.
Canny investors would do very well to keep this bias in mind. And perhaps use it to their own advantage the next time that they are in a negotiation.
Bias 2: Mental accounting
Mental accounting: is the tendency for people to separate their money into separate mental ‘accounts’, based on a variety of criteria such as the source of the money and the intent of each account. A person may, for example, keep a savings account for a holiday, notwithstanding a high interest credit card debt that should, rationally, be paid off first.
Similarly, people tend to treat money differently depending on its source. Unexpected or ‘bonus’ money (such as tax returns, gifts and work bonuses) is typically spent, rather than saved.
Bias 3: Selective perception
We all like to believe that we consider things in an unbiased way. However, the reality is that we will often selectively perceive what we want to see. There are a number of ways that this can affect our investments. For example, we will place more trust in information coming from people we like. Further, once we form a view on a particular investment option (negative or positive), we will tend to retain that view, even if the underlying investment becomes more or less attractive. Thus, we can be 'emotionally committed' to an investment, even if it underperforms.
The most effective way to protect against this bias is to form objective criteria on which to make investment decisions. These criteria should be based on fundamental analysis, rather than information from one source. These criteria should also be applied (from the very outset) to exit decisions. In nearly all cases, at some point we will be looking to exit an investment. The circumstances of our exit should be determined at the outset, to remove the prospect of our decision being affected by other factors (such as emotional commitment). For example, if investing in the often-volatile stock market, some investors employ a 'stop loss' mark which triggers an automatic sale if a price falls beneath a pre-set amount.
Bias 4: Group dynamics
Much research suggests that well-organised groups make more accurate decisions than individuals. However, groups also give rise to investment fashions and 'groupthink'. The global finance crisis revealed many examples of extremely intelligent investors and institutions blindly 'following the herd' to investment oblivion. Individual investors always need to consider the fundamentals of their investment based on their own particular circumstances. Following the herd only increases the chances that you will invest in unsuitable assets.
Awareness is the key to protecting yourself against the risks inherent in group dynamics. Every investment decision should be made based on consideration of your existing portfolio, risk tolerance and investment approach. Whilst advantage can be taken of the strengths of group decision making, be extremely wary of people who are investing in something because 'everyone is doing it'. Further, if you are involved in any group decision making, watch for warning signs of groupthink, such as intolerance of scepticism. It is always worthwhile to surround yourself with people who will challenge your ideas.
Bias 5: Losses and gains
At the heart of this bias lies the Nobel Prize winning insight that investors fear losses more than we value gains. As a result, many investors delay exiting an investment at a loss or do so only very reluctantly. By contrast, when we invest in an asset that increases in value, we frequently want to take the profits to validate our investment decision (and, of course, to avoid the risk that we will subsequently be forced to exit the investment for a lesser value).
There are a number of strategies that can be utilised to address this bias. First, investors should take care not to review their portfolios too frequently. Although this appears counter-intuitive, the findings of behavioural finance suggest that over-frequent reviews highlight short-term market fluctuations. This can lead investors to lose sight of their overall goals.
Second, 'stop loss' marks should be set at the time of investment, so that investors have objective and concrete criteria to determine when an investment should be sold. This can help investors avoid clinging to losing investments for too long.
Finally, investors can manage their loss-aversion by investing in products with some form of capital protection.
Bias 6: The fun of speculative investment
Although investors are generally very loss averse, this conservatism seems to change dramatically when we are presented with risky investments promising high returns at low investment cost. The popularity of lotteries is a good example of this bias in action. Neurological studies show that risky investments can often trigger 'reward' parts of the brain, regardless of the investment results. In other words, for many investors, risky investments are fun!
The intelligent investor can protect against this bias first and foremost by recognising it. Once recognised, it can be managed and channelled. One way to do this is for investors to invest a specific and pre-determined amount of their wealth in speculative investments. The rest of the portfolio can be devoted to less risky options. Further, high risk investments often incur losses, so investors need to be careful not to 'throw good money after bad.' When 'stop-loss' thresholds are triggered, we must be disciplined and exit the investment. Finally, all speculative investments should still be made based on a solid investment case, rather than hunches and intuition.
Bias 7: Decision making rules
One advantage that the human brain has over computers is its adept use of heuristics or 'rules of thumb' to make speedy decisions amidst uncertainty. Although extremely useful, these heuristics are also prone to error. There are many examples that can be used to illustrate this:
- Studies show that our memories do not 'store' events, but reconstruct them on the spot, filling in missing details based on relevant information. Further, we have a tendency to forget negative experiences faster than positive ones and have a 'hindsight bias' that convinces us in retrospective that we 'knew it all along'.
- We often assess probabilities of events based on how closely it represents a scenario that we already have in our minds. Thus, for example, if a tossed coin produces tails three times consecutively, most people assume that it will next land on heads, even though another 'tails' result is equally likely.
- The more frequently an event has occurred to us personally, the easier it is for us to imagine that it will happen again. We therefore project our own past experience into the future.
- From an economic point of view, it does not matter how much money (or time) we have invested into something. The only relevant factor is future costs and benefits. However, we are frequently reluctant to abandon something into which we have poured money or effort and such decisions are often the most difficult for investors.
The key way to protect against these decision making biases is to impose the discipline of rational thinking on all of our investment decisions. We should keep accurate records of key information, not rely overly on our own inclinations and subjective experiences, not assume that chance will be self-correcting and be honest when we attribute success and failure.
As can be seen, there is a lot more going on when an investment decision is made than the 'rational investor' assumption would have us believe. But by understanding the psychological factors influencing all of our decisions, investors can control for them and ensure that our decisions are truly intelligent. And if we do nothing this year’s end other than review our own investment decision-making processes, we will have made an outstanding investment in our future.
Market update & investor briefing
Invest 30 minutes of your time to hear from our quarterly market update and investor teleconference.
Our presentation will cover the domestic and international trends and our ‘headwinds and tailwinds’ analysis. We will also update you on the Australian property market and our Credit Fund performance in the last quarter.
||Wednesday, 27 April 2016
ACT, NSW, QLD, TAS, VIC
12:00pm - 12:30pm (AEST)
||11:30am - 12:00am (ACST)
||10:00am - 10:30am (AWST)
Connect through your computer or by telephone
Further details will be provided on registration.
Click here to register your interest in participating