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Incentive Drives Behaviour

Investors can pick up a newspaper and, on the same day, sometimes on the same page, read a bullish and then a bearish forecast.

It could be that investment managers and market strategists look at different attributes and draw differing conclusions from the same data. For example a micro (bottom-up) manager might have one view (regarding an individual stock, say) while a macro (top-down) manager might have another view (based on an economic theme and it’s impact on an individual stock, say).

The point is that the views are often not just different but divergent.

How does an Individual Investor select between the two brands of investment management?

One wonders if the difference might be the source of the view. Independent (manager-owned) investment manager forecasts tend to be more sober. When the forecast comes from an investment manager that is tied to an investment bank, however, the view tends to show less restraint. (There is ‘career risk’ at an investment bank for those with a bearish view).

This makes intuitive sense at the most basic level. Incentive drives behaviour.

Independent investment managers, as owners, have their own money invested in the firm. They likely manage their own money in-house. And owner-mangers don’t want to lose their own money. (Duh)! Client assets ‘are’ the business and thus are protected and preserved with a prudent view and risk management approach … ‘as if’ the assets were the managers’ own.

But some investment managers owned by an investment bank might be paid for driving revenue. And performance drives revenue … not risk management.

Indeed, manager-ownership is one of the manager selection criteria Institutional investors consider.

Next time?
What is a global stock?
Doug Cronk CFA is Manager, Investments for a Canadian Pension Plan
3 Comments Post a comment
  1. I have to agree with the first paragraph. Actuaries have updated discount rates and reduced expectations. There is much written on ‘curb your enthusiasm’ for normal or average returns … the expectation is for below average returns for the foreseeable future. (I’ve written about it too see:
    Altho’ the PIAC asset mix doesn’t really show it yet (due to reporting lag), there is a big move towards alternatives in the hunt for yield.

    Re: the individual investor? I disagree.

    Most individuals ought to build a conservative, moderate or growth oriented balanced fund/portfolio of sorts … and rebalance, reinvest dividends and dollar-cost-average. Very few of us should attempt take on tactical bets … unless your personal, financial circumstances have changes that have impacted your risk tolerance or return requirement … then change your ‘strategic’ mix.
    Old school, i know, but it works.


    June 1, 2011
  2. diversifyme #

    Hi Doug. The following quote is from Howard Marks’ (Chairman of Oaktree Capital) recent weekly commentary. I’d be interested to hear your thoughts.

    “Today, pension funds and endowments simply can’t achieve their goal of nominal returns in the vicinity of eight percent if they keep much money in Treasurys or high grade bonds, and they may not even expect public equities to be much help. They’ve moved into high yield bonds, private equity and hedge funds . . . not because they want to, but because they feel they have to. They just can’t settle for the returns available on more traditional investments. Thus their risk taking is in large part involuntary and perhaps unenthusiastic.”

    From the perspective of an indivudal investor, this almost argues for adopting a slightly more conservative position (e.g. short bonds) regarding asset allocation.


    PS: The whole commentary:


    May 31, 2011

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  1. Bloomberg Bond View. « Institutional Investing for Individual Investors

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