Investment Strategies

Building Composed Investors With Behavioural Finance - The Barclays View

Tom Burroughes Group Editor 30 July 2019


The UK bank argues that it has been a trailblazer in the field of behavioural finance and continues to devote resources to building expertise and client solutions.

A term that sometimes comes up in areas such as sport is “composure”. How “composed” is a footballer in possession of a ball in midfield or how “composed” is a cricketer when handling fierce bowling?

One tends to encounter this word less in the field of investment and wealth planning, but that’s a mistake, say advocates of behavioural finance. It is worth knowing how confident and composed a client will be when markets become volatile or if unexpected events force them to re-think how they manage money. Composed people, so the argument goes, are more likely to succeed in reaching their targets and less prone to panic and making mistakes.

One of the firms that is often associated with behavioural finance is Barclays, and specifically, the bank’s wealth and investment arm. That UK-listed lender has pushed understanding in this area for well over a decade, when noted behavioural finance figure Greg Davies (interviewed elsewhere by this publication) joined in December 2006 to create a behavioural finance team. Dr Peter Brooks, who now heads it up, joined a few months later, in March 2007. Even though Davies has moved on to other things, the bank’s commitment to driving understanding of this subject remains strong, Dr Brooks told this news service recently.

It is sensible for wealth advisors to understand their clients’ mindsets so they can calculate whom to contact first when, for example, there is a market or political shock of some kind. Knowing who the less “composed” clients are, advisors can contact them first to put their minds at rest, rather than simply assume that they must get in touch with their largest, richest clients, Dr Brooks said. (Under the MiFID II European investment reforms, market practitioners have to notify clients when their portfolios drop by more than a certain amount.)

“The insights of behavioural finance allow you to understand that you can coach the client in some ways,” Dr Brooks said in a recent call.

In some ways the objective is for a client to be comfortable in all market environments rather than simply aim to maximise risk-adjusted returns, he said.

Dr Brooks spoke about the concept of the “behaviour gap” – the difference between what an investor receives and what he or she could earn had their behavioural tendencies been more accurately handled.

He refers to the Dalbar Quantitative Analysis of Investor Behavior, which has showed that the “gap” can be as wide as 3 to 4 per cent, while studies in the UK, Dr Brooks said, suggest that the gap is narrower. However, even at a 1-2 per cent gap, for example, the law of compound interest can add up considerably over time.

Dr Brooks is an economist by training and an example of how behavioural finance has permeated modern economics. He earned his doctorate in behavioural economics and has worked at the University of East Anglia.

As this publication can imagine, Dr Brooks is delighted that Richard Thaler, who co-wrote the book Nudge with Cass Sunstein, won the Nobel Prize in economics in 2017. As already reported, Dr Thaler has been named an advisor by PIMCO, the bond fund management giant – another sign of how such ideas are spreading into the mainstream. And as Barclays likes to point out, Nudge was published a decade ago, after the bank’s team was created. (When banks are sometimes assailed for being trend-followers rather than setters, this is a point the UK bank likes to point out.)

Building comfort
With academic subjects, a question the layperson will want to ask is where do these insights affect clients in real life? One answer, Dr Brooks said, is that the bank is changing how information is conveyed to clients so they are less likely to panic or react hastily.

Barclays is working on investor platforms so that clients aren’t led to make unnecessary changes by seeing the latest daily shifts in a portfolio. Instead, they will see 12-month performance. The idea is to change how people “anchor” their investment views, he said.

“That is the sort of way that the insights that come from the team are making a difference to investors,” Dr Brooks continued. “Generally, rising awareness is helpful because you can do something about it.”

The key to the ideas of behavioural finance is being able to use its insights when you need to do so, not just in an academic setting, Dr Books continued.

Technology has been a big factor in driving the subject; the insights have been around for decades or more but data gives managers the ability to deploy these ideas on the ground, such as with use of Big Data.

“You have a nice confluence of factors to put the power of behavioural finance into the hands of people as consumers and as investors,” Dr Brooks continued.

How can a firm check whether it becomes more profitable and earns more revenue by adopting behavioural finance?

A sticking point is proving counter-factuals ie what happens had a behavioural approach been embedded into processes? At present, this is difficult if not impossible to do. However, there are clear results that make the area compelling for firms, such as improving the “share of wallet”, deepening client relationships, improving the onboarding experience, and reducing client attrition rates, Dr Brooks added.

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