The investment advisor knows exactly how to identify and implement the needs of the investment client. However, as a new study has shown, in reality it is mainly irrelevant factors such as the personal mood of the advisor that determine the investment recommendation.

Often, investors are thwarted by their gut feeling. It turns out that investment recommendations from the same advisor and with the same fundamentals can vary greatly at different times. However, this does not only happen to private investors, but also to professional investment advisors. The study comes from Oxford Risk, a company that spun off from the university of the same name and deals with behavioural economics in the financial markets.

The study aims to show how different investment recommendations are made to clients with the same requirements. For this purpose, the authors provided various investment advisors with relevant and irrelevant customer information, including the risk tolerance of the person concerned. Based on this information, the risk capacity of the client is to be estimated and an asset allocation recommended.

Four factors are important

The factors that lead to the investment decision can be divided into four groups. The first factor: explainable and relevant ones such as risk tolerance. “According to our research, this data only contributes about 30% to the investment decision,” says Greg Davis of Oxford Risk. Furthermore, there are explainable but irrelevant factors such as gender and skin colour of the client or age and marital status of the advisor.

Peculiarities that appear in all advisors but cannot be explained are cited as a third factor. And fourthly, there are factors that are individually different, but also not explainable. For example, the recommendations made by the same advisor with the same basic principles varied greatly at different times. The study authors cite factors such as different personal moods, the time that has elapsed since the last meal, or the weather.

The last three groups of factors, which should actually have no influence, are referred to in the study as “noise”. These discords mean that the recommendations of different investment advisors to clients with identical circumstances yield surprising variations.

“Advisors’ assessments were closer to total coincidence than total consistency,” the study says. There were also further differences in the implementation of client assessments. In this case, the portfolios of clients who were attributed the same risk capacity showed highly different risk levels.

 

The human aspect is fundamental

The authors of the study see the use of technical aids, in this case software, as a solution to eliminate the “noise” – although it should be noted that Oxford Risk has just such an application on offer. According to Greg Davies, this study, which was conducted in South Africa, has also received interest from other countries.

Results from studies developed in the UK and the US have shown that investment advisors in these countries would also behave quite similarly to the study, i.e. irrationally.

According to Oxford Risk, the technical tools should not be designed to give an investment recommendation. The point is to technically check whether the guidelines are being adhered to. This is comparable to the VAR (Video Assistant Referee) in football, which is used to check compliance with the rules, but otherwise has no influence on the course of the game.

 

Solutions offered by Nemesis

The solution offered by Nemesis is to leave the decision-making process to a defined investment team who can rationally design and apply the investment decisions, as free as possible from any psychological or emotional stress.

In the investment process, the key is whether the risks taken are within the clients’ risk tolerance and are properly implemented in the portfolio. It is like a visit to the doctor: the medical practitioner uses diagnostic equipment such as blood pressure measurement or X-rays to provide information about the state of health, which is adapted to the individual needs of the patient.

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