Investment Strategies

Behavioural Finance Tested By Extraordinary Times

Tom Burroughes Group Editor London 1 May 2020

Behavioural Finance Tested By Extraordinary Times

The discipline of behavioural finance has evolved over recent years, and the massive economic changes wrought by COVID-19 give examples of how the insights are being put to work in the wealth management industry. There is still big room for development and education, people working in the field say.

Human emotions are being pulled about a lot at the moment, and no wonder. Consider the following: Market slides, economic lockdowns and angry words exchanged between China and much of the rest of the world; daily headlines of COVID-19 deaths, rising unemployment and cancelled cancer operations. 

The upheavals caused by the pandemic have hit people across a number of fronts, and one obvious result has been the heavy fall in market indices since the start of the year. The worst of the rout saw broad indices fall by as much as 30 per cent or more. As of the time of writing, indices are down by around 15 per cent. That’s not as dramatic as the 22 per cent fall on the 19 October 1987 stock market slump on a single day. Or, to take another example, the dotcom era saw stocks crash by almost 78 per cent from their peak. But even if markets recover eventually, investors had a rude reminder of how fast things can move. And because of that, the lessons from a growing discipline known as behavioural finance remain hugely relevant. 

Behavioural finance tries to delve into the real drivers of human conduct to understand events such as market booms and busts, why people can allow biases to lead them into mistakes and other issues.

A hope that some BF advocates have is that advisors and their clients will put these insights to work, learning to be more resilient during tough times and avoid panic and costly errors. It turns out that the behavioural finance revolution has a while to run before it becomes part of investors' mental furniture, however. 

"A lot of advisors could have been better prepared than they are," Greg B Davies, PhD, who works for Oxford Risk, which delivers insights drawn from behavioural finance for the industry, told this news service.

Hopefully the COVID-19 saga will give behavioural finance a big push, said Davies, who before working at Oxford Risk had created his own consulting firm Centapse, and prior to that, worked for a decade at Barclays, heading its behavioural finance team.

Davies argues that while the pandemic has shocked people, it should not be viewed as a “black swan” event, because the world has been shaken already by health crises such as SARS, Ebola and Swine Flu.

Across the Atlantic, Jon Blau of Fusion Family Wealth, a US wealth manager, said that behavioural finance “is at the core of our being as a business”.

“We specialise in helping investors learn to make rational decisions about money under conditions of uncertainty – which is all the time.” ….”Certainty doesn’t exist anywhere in nature”,” he said. 

In terms of how to prepare clients for a shock, one should think of it as a lifeboat drill. “You need to know where all the safety equipment is long before the bow goes into the water,” Blau said. 

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