True Risk Management

Natixis Asset Management uncovered a very interesting fact when institutional investors were recently surveyed. 74% of investors say they have changed their approach to risk management in the past five years, and 70% are more confident that their current approach to risk management is right for volatile markets. If the finding doesn’t inspire confidence, that is because it shouldn’t. The numbers show that though most of the surveyed institutional investors thought their previous strategy needed to be changed, they view their current strategy as being the right one. It seems logical that five years ago, those very same professionals thought they had the correct strategy in place.

The data highlights two common behavioral finance errors: recency and overconfidence. Recency is defined as a time immediately before the present. Behavioral finance describes it as forecasting future events based on recent conditions. If the markets are currently volatile, recency bias causes an investor to believe the markets will be volatile into the future. Eight in 10 global institutional investors told Natixis that market volatility is here to stay. The inherent danger with recency is that market sentiment is unpredictable. The mood can change quickly and there are never flashing signs telling you that conditions are suddenly different.  Though beliefs in one’s ability to pick good investments and manage a portfolio are important, having too much confidence can be dangerous. This is particularly the case when a specific outlook is adopted and a portfolio is managed accordingly. We have seen many famous cases of overconfidence leading to disastrous financial results. Surely, the people running Bear Stearns and Lehman Brothers thought their firms were not at risk of collapse. A person stating an opinion with enough confidence can get others to believe him, even if his viewpoints are wrong. Calling for a calamity or a raging bull market is a great way to sell books but following such forecasts is rarely a good long-term investing strategy.

I mention these errors because we have a multi-tier investment strategy for each client.  We are investing given the clients long terms goals but with a short term risk management overlay.  Our sector focus changes as the economic and political landscape changes. Static asset allocation is not followed. There will always be suggestions that things are different this time.  Clients constantly try to get me to overweigh a particular stock or investment sector. Feeling comfortable is not an investment strategy. Shorter-term market moves will make a long-term strategy appear to no longer work properly. Over longer periods, short-term strategies often fail, while those clients who stick to our long-term strategies often prevail. This is why you should always be careful not to let your allocation be determined by short-term events or market pundits disguised as so-called experts.


Disclosure: The posted information is for informational purposes only. This message does not constitute an offer to sell or a solicitation of an offer to buy any security. All opinions and estimates constitute Karp Capital's judgment as of the date of the report and are subject to change without notice. Accordingly, no representation or warranty, expressed or otherwise, is made to, and no reliance should be placed on, the fairness, accuracy, completeness or timeliness of the information contained herein. Securities offered through Infinity Financial Services (a registered broker-dealer, member FINRA, SIPC). Infinity Financial Services and Karp Capital Management are not affiliated companies.


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Comment   |  5 years, 11 months ago from San Francisco, CA