According to the latest research among active private investors for Consensus Research’s Investment Funds Survey, 44 per cent of respondents describe themselves as no-risk or low-risk investors while 49 per cent regard themselves as moderate-risk investors.
Yet when the same people are asked which investment markets appeal to them most over the next 12 months, the short list they name includes China, India, emerging markets generally, Brazil, Latin America generally and Russia.
These are not markets we think of as no risk, low risk or even moderate risk. Are these people simply stupid or are they just saying the first thing that comes into their heads to the research interviewers?
In my experience, when consumers say things we do not understand, it is almost always because their mindset is different from ours. Not better, not worse, just different.
Consensus Research’s findings got me thinking about consumer mindsets towards investment risk.
To us, this is largely an issue about asset classes and diversification. Some asset classes and/or markets are riskier than others and badly diversified portfolios are riskier than those that are well diversified.
I am sure a lot of more sophisticated private investors see things in just the same way – but a lot do not. Many, I believe, think about risk and risk management in very different ways – perhaps three different ways in particular.
First, they believe you manage or even reduce risk primarily by choosing the right fund and the right fund manager, not the right asset class or market.
What does right mean in this context? According to Consensus, it means right as recommended by an expert (usually an IFA), right in terms of having a proven record of past performance (59 per cent say this is a key factor in their fund selections) and right in terms of any other confidence-inspiring factors that come to hand (Fidelity China special situations is a low-risk fund because it is managed by Anthony Bolton and he is really good).
Second, the concept of risk for investors is inextricably linked to their immediate level of confidence in the markets. On the whole, when markets have been rising (ideally strongly and sustainedly), the outlook is good and investing is not risky. When markets have been falling, the outlook is bad and investing is risky.
This way of thinking has a very confusing effect on risk-profiling tools. Often, when investors say their appetite for risk is high, what they really mean is they are confident in the future of the markets and think that even if they make riskier investments, then they are unlikely to lose out. Vice versa, when they say their appetite for risk is low they often really mean the markets look dodgy and they would rather not do anything too brave.
Third, many investors do not actually have a single attitude to risk at all but a number of different attitudes. These exist in their minds both simultaneously and consecutively and depend on a whole range of things, such as what they already have in their portfolios and therefore what gap they want their next investment to fill, how they see the economic climate and how anxious they are about losing their jobs, whether or not their teenage kids are going to scrape under the wire on the university tuition fee increases, what someone said in the pub the other day and so on.
The idea that they have any single and sustainable attitude to risk that exists across the breadth of their investment behaviour and continues over long periods of time is absolutely false. Even if they did, it would often be so weakly held that it could be overridden at any moment by some excitingly written copy for a Bric fund or, worse, by a telephone call from a Buenos Aires boiler-room punting a non-existent Azerbaijani mining stock.
In all three of these ways, many private investors think very differently about risk from investment professionals. As a result, things they say and do seem inexplicable to us. How can anyone who describes themselves as a low-risk investor be piling into special situations in China?
Equally, things that we take for granted do not make much sense to them.
Why do we say, for example, that a fund with a concentrated portfolio of 20 stocks that has increased in value by 40 per cent in six months is riskier than a fund with a portfolio of 100 stocks that has fallen by 10 per cent?
Misunderstanding begets miscommunication unless, of course, it is the other way round. And while all of this may not matter too much when most investment decisions are made on a private investor’s behalf by an intermediary, many people believe the retail distribution review will trigger major growth in direct-to-consumer investment propositions, mainly based on online platforms.
If that is the case, investors who are not very sophisticated are going to need to develop the ability to make intelligent investment decisions on their own.
In the long run, I believe we can only enable them to do this by developing a whole new language and interface to manage the interaction between consumers and the world of investment. But that is a whole other subject.
We also face a smaller but still difficult challenge to find a common basis of understanding within which we and our target market can talk intelligibly about key issues affecting their decision-making – and among these key issues, risk comes pretty high on the list. At the moment, the evidence from Consensus Research seems to suggest it is something of a dialogue of the deaf.