What do investment clients expect of returns, costs and risks? Value for money is a difficult concept, possibly beyond calculation. It is not that cost is difficult to compute, benefits can be uncertain and intangible.
Brand name, trust, and press comment all combine to frame retail investor hopes. Product marketing alone cannot control those expectations ― psychology also comes into play.
Much of this is unconscious, or at least unspoken: we may only learn about unrealistic expectations when star investors fall from grace. These investment tragedies can finally reveal how much is intangibly embedded in choice of funds and fund managers.
The concept of designing products for a specific target market is praiseworthy. But, can we ever regulate for unrealistic investor beliefs?
The likely costs
It is not just an issue of whether a fund manager has promised exceptional performance. Those promises have been regulated out, leaving us with historic numbers and likely costs. But, retail investors rarely have the skills on which prospective costs and benefits can be calculated.
They are given risk indications, reduced to a single number, that treat low volatility caused by illiquidity as a positive.
Despite the numbers, extensive academic research has shown the extent of emotion involved in financial decisions.
We would all like to believe in the existence of an exceptional fund manager who can smooth out the stockmarket rollercoaster. It may even be that fund managers foster this illusion of control by claiming too much credit for outcomes that are essentially random.
One investment trust chair recently cited a six month record under a new approach as ‘demonstrating that it can deliver outperformance’.
Investors may also set store on the comfort of established brand names or longstanding institutions. Yet few longstanding funds have applied the same investment process throughout, never mind kept the same individual fund manager.
Investors struggle to comprehend just how noisy an environment investment is. Studies have suggested that it takes 22 years to be confident that a track record is predictive in terms of skill. Of course, with those that have below average skill, we can often draw conclusions from shorter periods.
The thrill of performance
The role of fantasy and ‘phantastic objects’ is well documented in psychology research. Judgements about risk and reward become compromised by the thrill of potential performance. Investors move from grounding in the real world to idealise an opportunity.
This excitement can disconnect us mentally from anxiety about adverse outcomes, leading to group think and bubbles. When this unwinds, and anxiety suddenly reasserts, it can be traumatic.
The reassertion of common sense as we realise a star manager has flown too close to the sun, brings us down to earth with a jolt.
For example, when a manager has performed strongly over decades in UK equities, it is all too easy to believe this skill can be effortlessly translated to picking shares in China.
And, when a manager has correctly called two bear markets, our guard is down. Combined with the social proof of others piling in, supported by press lionising, can make it hard to see straight. It may not be the fault of any marketing material ― it is just that investment choices are made against a background of reputation and psychological biases.
Trust is key
Trust and brand have positive roles to play; where investor anxiety is reduced it can stop wasteful fund switching. Some analysts have suggested that investor switching and attempts to time markets can cost just as much as underlying fund charges.
Product providers and regulators will need to puzzle over how they can separate this positive quality of brands from what might look like additional expense. Much more study is needed of this before it will be possible to draw useful conclusions about value for money.
Meanwhile, the fall from grace of funds that too rapidly became consensus investments show how much emotion is involved in fund selection.
Colin McLean is founder and director of SVM Asset Management. His UK Growth fund, which he runs alongside Citywire A-rated Margaret Lawson, has returned 30.8% over three years versus a peer average of 21.3%.