Kwowing your emotional bias is key to wise investing

Top investors are studying the notion of ‘bias’ to find what separates winners and losers in the sharemarket.

Platinum Asset Management co-founder and managing director Kerr Neilson.

What is the biggest factor in ­investing? What is it that separates the winners from the losers? You might think it’s experience or numeracy or a particular understanding of an industry. All of these factors will be relevant but the distinguishing feature is surely the presence of bias.

I recently chaired a session with investment legend Kerr Neilson of Platinum Asset Management. Neilson used his address to an audience of private investors to expand on what you might call behavioural economics or more precisely investment bias.

As Neilson held forth on the mistakes and major decisions investors make which determine their success I feared the audience would be disappointed. In fact, I was struggling to think up questions for the post-address Q+A because I wanted him to talk about the market and what stocks he likes the best.

Then it struck me: here’s an investment expert; he’s a billionaire; he knows absolutely everything you need to know about investing … and when you get to that level all that’s in the way of your successful reading of the market is “bias” — the emotional rather than rational ­decisions you make as an ­investor.

So are you biased? One way to find out is to measure yourself against the crowd. Here’s some of the more obvious points of bias we know to exist in the Australian market:

● There is a bias towards residential property. Investors will accept high prices and low rental income to buy bricks and mortar. Moreover, they will “gear” to dramatic levels. Indeed, they will take out 100 per cent mortgages because they can “feel” property, even though property is a difficult and illiquid asset class.

● There is a bias against shares. We know that shares outperform all other assets classes over time yet retail investor ­participation in the market has yet to return to pre-GFC levels. And if gearing is a vote of confidence in an asset class then shares fare miserably, yet it is indisputable on any metric historic or ­actual that shares in Australia represent better value than residential property.

● As an investment community we have a bias towards tax ­favourable investments — often regardless of investment principles. Who can forget the rush into managed investment schemes a decade ago where the rush for tax write-offs created a disaster?

Today we have a rush for negative gearing in residential property and of rising concern is the “hunt for yield” among franked blue chip shares typified by bank stocks, which each month offer lower yields but continue to rise higher in our estimation. Gerard Minack, the “bear” who called the last crash most ­accurately now calls our bank-led stockmarket a “yield pain trade”.

● As an investment community we also run with the herd. It’s the main reason markets crash: everyone piles in at the top when valuations are at their worst. I have a friend who has “entered the stockmarket” on two recent occasions: 1999 at the peak of the dotcom boom and in 2007 at the peak of the last bull run. I’ve asked her to let me know when she gets the urge to buy shares again!

● As individuals we have bias towards selling our “losers” and holding on to our “winners” when all rational thinking suggests it should be the other way round.

● As individuals we also have a bias towards an illusion of ­control: this explains to some ­degree the love of residential property across the market — if a property falls in price you can improve it; if a share falls you can’t do anything except sell it. Sadly though, renovated houses in a market where prices are falling invariably do not reward the investor/renovator — they reward the buyer.

As you can see from even a cursory reading of the list above, very few investors can say they act without bias. Indeed, it’s not just market wizards such as ­Neilson at Platinum who are taking the issue of investment bias seriously. The Australian Securities & Investments Commission has recently commissioned a study in the area to try to understand why retail investors often without professional advice — and invariably without fully understanding the risks — are swarming into hybrids: the listed securities that are a blend of shares and fixed-income notes.

ASIC noted that hybrid investors displayed a framing bias and a branding bias.

With hybrids the framing bias was that the products presented themselves as simple propositions which offered income, but they were much more complex and risky than ­investors expected.

The regulator also noted a branding bias with hybrids where investors might make decisions based on the familiarity with brands — the regulator did not name banks but you can safely conclude that is what they were talking about with the bulk of ­recent issuance in this area coming from the big four.

But back to Neilson and his bias lecture.

For me the most interesting nugget came when an audience member who had been asking about a share that had lost them money was asked by Neilson what had happened to the stock in the months after the audience member had sold out.

Like many investors might have answered, the speaker replied she no longer cared. Neilson then coolly explained he would never have an analyst working with him give the same answer. It’s from our losses we learn, he said.

In this relatively benign ­climate for investors where you have both share prices and property prices rising at the same time the issue of learning from your own bias may be less apparent — a rising tide covers many mistakes, the more you understand the emotional side of investing the better investor you are going to be.