Managing human biases through goal based investing

Rajendra Kalur 

The role of an Investment Advisor is often misunderstood and confused with that of a portfolio or a fund manager. No wonder that very often in client reviews and presentations, market talks and portfolio performance form a dominant part of the conversation. So who is responsible for the confusion, in the first place. I have no doubt that much of this blame should go to the Investment Advisors.

Very often Investment Advisors make the mistake of talking what the client wants to listen and avoiding the uncomfortable job of making the client do what is right for his goals. While investment performance does matter, it’s not the sole objective. Hence measuring an advisor’s performance solely on the basis of portfolio returns is not only incomplete but also dangerous in the long run.

To understand more on this, let’s study the experience Mr. Shroff had during the recent portfolio review with his SEBI registered Investment Advisor. Mr. Shroff was waiting expectantly for this review. More so since he has been introduced to a couple of products by a distributor that his RIA had not recommended. In the past, Mr. Shroff had refrained from mentioning about products and always allowed his RIA to recommend during the review.

However the features and the recent performance of these products were exciting enough for him to seek the RIA’s opinion. Mr. Shroff’s advisor continued the review in the usual manner and measured the portfolio’s performance against the client defined goals. No words were said about any changes to the portfolio nor did the advisor make any mention about these 2 products that Mr. Shroff was excited about. This prompted Mr. Shroff to find out why the advisor hasn’t recommended these two products.

While 1 product was a small cap oriented MF the other was an Alternate Investment Fund investing in High Yield (read High Risk instruments). The Registered Investment Advisor looked at Mr. Shroff and explained to him in a dispassionate manner that while the small cap fund had indeed shown a spectacular performance in the recent past it comes with a lot of risk attached.

Small caps have a high drawdown risk as well as very high liquidity risk in times of market stress and knowing Mr. Shroff’s goals and conservative profile he is better off avoiding the fund. Similarly, prudent exposure limits would be severely tested if large sums are poured into a second instrument. Several Investment Advisors are familiar with the classic herding behaviour that Mr. Shroff has displayed in the case above. Goal based evaluation helps in getting the client to focus on the critical items and avoid mistakes of herding. Similarly other human biases like Overconfidence, Over & Under reaction, Loss Aversion and Regret Aversion can be avoided by Goals based investment.

Author is is a CFA charterholder and the chief executive officer of TrustPlutus Wealth Managers (India) Private Limited

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