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Adapting to survive and thrive

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"The good news is that while we display behavioural biases and can sometimes make sub-optimal decisions, we have the ability to learn from past experiences and adjust our heuristic in response to negative feedback." - Alexis Calla.

ASIA'S first generation of high net worth individuals are driven by their entrepreneurial, wealth creation instinct. Many of them have prospered, in part, by being agile and capitalising on market opportunities they see. Singapore, with its ease of establishing and conducting business, counts entrepreneurship as one of the key drivers of economic success - in fact, six out of 10 ultra wealthy Singaporeans are self-made.

While these behavioural traits have contributed to the success of their businesses, relying on intuition and past experiences alone in making investment decisions may not always result in the best outcome. Our human instinct for survival has led us to develop tendencies to think in certain ways - for example the availability bias (relying upon knowledge that is easily available) or the confirmation bias (interpreting new evidence in a way that confirms one's existing beliefs), which can give rise to a natural bias among entrepreneurs when choosing investment opportunities correlated to their business or home market. This tendency to limit the rules of engagement to familiar asset classes or industry sectors means these high net worth investors may sometimes be prone to making decisions that negatively impact their portfolios in the long run.

INFORMATION OVERLOAD

The challenge of information overload further compounds this problem. It is estimated that in the course of a day, an average person is exposed to as much data as someone in the 15th century would encounter in their entire lifetime.

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The volume of information business owners has to consume and analyse is substantially more, as they are often involved in the end-to-end operation of their companies.

Given the combination of a very natural tendency for bias - both home bias and behavioural bias - and the lack of time to keep check of one's human instinct, what these high net worth business owners need is not a multitude of views which may often be irrelevant, but high-quality insights that enable them to make better decisions.

As the adaptive markets hypothesis - an idea borrowed from Darwinian biology that is articulated by MIT economics professor Andrew Lo - suggests, markets develop and adapt over time. In contrast to the efficient markets theory, Prof Lo's hypothesis argues that financial markets do not always follow rational economic laws. Instead, financial markets are a product of human evolution, and follow laws similar to the biological laws of natural ecosystems. As the basic principles of mutation, competition and natural selection determine the evolutionary journey of a herd of antelope, the degree of market efficiency is also related to a combination of environmental factors.

How does this translate into day-to-day investing?

We believe that an adaptive investment process is needed in response to an "adaptive markets" environment. The idea of "adapt to survive" articulates the importance of adaptability, and the ability to do so in the face of changing market conditions will be key for investors to achieve a consistent level of return. For us, a powerful resource exists in diversity. This adaptability of an investment process could be best achieved through a combination of access to diverse insights and a rigorous and unbiased collective decision process that ensures individual judgment biases are reduced and our natural instincts are countered.

This suggests that entrepreneurs need to understand and acknowledge their behavioural biases. In addition, they should leverage the skills and experience of professional advisers such as their wealth managers to provide access to a diversity of views combined with an unbiased approach to process them, empowering them to make superior decisions.

Successful advisers should recognise the importance of culture and behaviour traits in their clients as part of the investment process, and adopt a flexible approach to portfolio construction. Their views also should be guided by the collective intelligence of a group of experienced and diversely informed experts, rather than individual specialists to limit or reduce individual biases

ANOMALIES IN MARKET BEHAVIOUR

From the speculative bubble in technology stocks to the 2008 financial crisis, anomalies in market behaviour sometimes defy economic rationality and challenge the common belief in efficient markets. The good news is that while we display behavioural biases and can sometimes make sub-optimal decisions, we have the ability to learn from past experiences and adjust our heuristic in response to negative feedback. Adapting our behaviours in response to changing market conditions as the risk-and-reward relation evolves is key to surviving and thriving in today's ever-changing investment environment.

  • The writer is global head, investment strategy & advisory, Standard Chartered Private Bank