This podcast is brought to you by Absa, a member of Barclays. Biznews’ Alec Hogg is with Roland Rousseau, Head of Barclays Risk Strategy Group. Roland youâve just had a presentation here. I think that after 30 minutes, many people were starting to say, âGoodness me, the world is starting to change.â Itâs all about risk.
Yes. We are moving away from literally, 100 years of trying to find fund managers to try to understand whatâs driving the returns in a portfolio. Often, these returns are not under the managerâs control. They are risks in the market and if we can break that risk down into the sub-components, we can actually do better active management but itâs active risk management rather than trying to beat benchmarks.
There was quite a lot in there as well about the risk of simply being a human being.
Yes, I think there are a lot of behavioural biases that have been picked up in the last 15 year and we, as humans, are very prone to making consistently poor decisions. The irony is that the experts (not just in finance, but experts in general) are even more prone to making consistently bad decisions because they have the fear of regret and the fear of being wrong. Bias is the way you react to news. You could under-react to news because itâs not what you expected or you could overreact to news, which is a behavioural bias as well.
You went through the history of investing. You put a couple of our heroes up there (Benjamin Graham and Warren Buffett). That school though, has now been superseded by more modern ways of approaching it but surely, Benjamin Grahamâs approach of âMr Marketâ, this crazy guy whoâs a manic-depressive also describes, quite accurately, the human beingâs ability to take on a lot of risk.
Well, the challenge for Benjamin Graham and Warren Buffett is that they rely on the original way to value companies, which is using fundamental data. However, a lot of the research in the last 40 years from people like Robert Shiller and Daniel Kahneman are showing that thereâs a lot more driving the market than valuations. So yes, Warren Buffett and Benjamin Graham could get it right in the very long run, but they could be wrong for very long in between. People want a more consistent return for their investments and the only way to do that is to actually, do more than valuations. Thatâs where youâre starting to look at risk modelling.
You mentioned Daniel Kahneman âThink fast and slowâ. How does that apply to risk and investing?
He won the Nobel Prize for doing experiments with (mainly) students to pick up on these behavioural biases and now, the industry is trying to convert those behavioural biases into the investment industry, which is quite a different approach. Having a few students in a room and trying to measure their biases, is different to measuring a bunch of fund managers and having their biases but there are common denominators and the big challenge is, âHow do we benefit from that?â Thereâs another Israeli gentleman â Daniel Ariely. He wrote the book âPredictably Irrationalâ and heâs also one of the leaders in converting these concepts from theory into practise.
These are all new ideas. Theyâve been around for a few years but theyâre new ideas in the investment field where many financial advisers are really, just looking to sell the next product and earn a commission.
Well, thatâs the problem. Financial advisors (and most people, even in the institutional investment space) rely very heavily on chasing past performance. That is a behavioural bias, in itself. Today, Paul Kaplan mentioned the concept of willing losers. Who are the willing losers? If value investing works, somebody must be underperforming or losing consistently and itâs probably those people who chase past performance, because we know that past performance doesnât tell you anything about future performance. That creates these biases and itâs very clear that the kind of concepts, such as anchoring and where we put more emphasis on recent information and past information â thatâs what past performance is, when you say âthe current winner is going to be the next winnerâ. That doesnât work so we are doing things in a wrong way.
Where do you even start?
We need a technology provider who can provide financial advisors (or anybody who wants to invest) with a see-through tool that shows you what those risks are in any strategy because Itâs not the manager whoâs in control. Itâs actually, the risks driving the portfolio and if you can see that, you can make better decisions. It might not even be an asset management business or an investment business. It might be a Google or an Uber coming along, giving us risk technology on our phones that will warn us as soon as portfolio breaches a certain threshold. Letâs say the Rand is suddenly becoming very important in my portfolio or itâs a very big risk in my portfolio, I want to know about that. Do you think that Allan Gray or Coronation is going to phone me and say, âThe Randâs risk has gone up in your portfolioâ? Of course not. So, whoâs going to do that? Somebody has to because thatâs how better investments will be.
I sensed, from listening to your presentation today, that quite a lot of the way you started thinking differently came from your experience with the Norwegian Sovereign Fund.
Yes, they had a bit of an epiphany in 2008, where they actually wanted to find out why they lost so much money in such a short period of time, given that they thought (and they were advised) that they were well-diversified and to a large extent, protected from these kinds of crash scenarios. They did lose 18 percent of the value of their portfolio in a single month and that was completely unacceptable to them, so they requested an official inquiry with three global academic experts, to do a study on this situation. The feedback was that in South Africa, most people rely on asset allocation as the only way to manage risk. In other words, how much do I have in equity bonds and cash? As you know, most investors are classified as high/low/medium risk and they get different asset allocations. That has now been proven to be an insufficient measure of risk (or adapting to risk), so the new way is to break down the equity, the bond risk, the credit risk, and the currency risk to sub-components in the same way that other areas are trying to get transparency in what is actually going on underneath it. It can break these big macro risks own into sub-risks. We might get a much better understanding of where the risk is so the Rand is an important risk, which affects both your equity and your bond allocation, but we donât see that if we only look at equity and bonds. We donât look at the risks within thoseâŚ
Did the Norwegians get it right? Have they changed things to that degree?
Yes, theyâve absolutely moved away from⌠Itâs basically, a granularity extension from big chunky asset classes to smaller Lego blocks and they are now, very much â and think about this – looking for simple risks that are uncorrelated to each other. If you put uncorrelated things together, you reduce risk. You actually improve your diversification. Equity and bonds arenât always uncorrelated. In fact, theyâre highly correlated in a crash, which is when you need it and thatâs why it doesnât work.
You mentioned âwhoâs going to Uberâ the investment industry in South Africa and the world. Weâve seen the rise of the robo-advisor. Might that be an Uber possibility?
Yes. Absolutely. In the independent financial advice space, you will see a huge application/innovation in how to advise people. I do think that smart financial advisors will use this technology to empower them rather than feel as though theyâre being dis-intermediated because they are the ones who actually, should be interpreting the risks that this app gives them. The end investor is not savvy enough to understand it. Thatâs why he has an advisor. I think that the new technology â the Uber app thatâs coming out â can literally, send you an SMS at any point in time when the risks breach certain thresholds, which you set for your client. Every client could have a different parameter set of âwhen the Rand is going to be this important in my portfolio, I want to know about itâ and it sends you an SMS. Then you can phone the client as a financial advisor and say, âLook, Iâm using this robo-tool, but this robo-tool says that weâd better do something because now you have a big exposure to the Randâ, so heâs empowered with that.
So, itâs reducing risk, making sure that you gamble less and as a result, your financial security will be far better in the longer term.
I think you want choice. You want people to know when something is going badly and currently, if you give all the money to the big fund managers they donât phone you and tell you. You just have to hope and pray that over the next five or ten years, they are managing the risk but you donât know. People want to know more. The irony is that people are now saying that skill is something that I canât actually see what it is. As Andrew Wilson said today, itâs fleeting and unobservable. We donât know what the skill thing is but we do know what the risks are, so why arenât we monitoring those things a lot more than trying to chase the fund manager whoâs just beaten his benchmark.
Roland Rousseau is the Head of Barclays Risk Strategy Group. This podcast was brought to you by Absa, a member of Barclays.
