Following the market meltdown caused by Covid-19, is this an ideal time for active investing to take advantage of mis-pricing opportunities as markets overshoot? Or it is better to hold low-cost, index-tracking funds on the basis very few active managers consistently outperform and market timing, even in a market crisis, is a mug’s game? New investment research and behavioural finance can shed some light on these questions.
CoreData recently conducted a survey of more than 600 institutional investors, gatekeepers and financial advisers around the world on their reactions to the Covid-19 pandemic and its investment and economic effects. The survey covered a series of topical issues, from what asset manager communications they valued most at this time to which aspects of working life during lockdown could leave a lasting legacy. Inevitably, investment plans and attitudes were also part of the research.
Without going into too much detail (because the research findings are for the firms that supported this project), one thing that struck me is that divergent investor reactions to the crisis can be partly explained by confirmation bias. In other words, whatever happens, individuals have the capacity to interpret it to support their dominant beliefs. We see this all the time, from our views on politics to our perceptions of others. And investors can be prone to this bias. The renowned economist John Maynard Keynes once said that when the facts changed, he changed his mind. But this can be hard for the rest of us to do because, at some level, it means admitting our previous view was wrong.
So institutional investors or financial advisers with an existing strategy of using active managers are likely to see the recent market crisis as vindicating a belief in active management. On the other hand, if they have an investment proposition based on passive investing, it is likely they will still believe in the long-term benefit of this approach. Certainly, our survey found very few plan to overhaul their investment proposition as a result of recent events.
But what frequently gets lost in the active versus passive debate is that investors don’t have to take sides. The truth is that many use both passive and active approaches within their overall investment approach. A common view is that it makes sense to take a passive approach in large, liquid equity markets, but to use active strategies in smaller, less efficient markets or asset classes. Or to have a core-satellite approach, with a low-cost passive core supplemented by high-conviction active satellites for a performance kicker.
And at the time of a market crisis, with high volatility and faced by big losses, investors using both approaches will tend to pivot towards more use of active investing, rather than emphasizing passive investing. Intuitively, this makes sense, as it fits a desire for control. It’s like a pilot switching from autopilot to manual controls when flying conditions worsen. An added impetus to action is that many investors now expect to fail to meet their short-term investment objectives. In this situation, taking action becomes easier to justify and it explains why we found an uptick in support for active strategies as a response to persistent volatility.
A final point to remember is that while markets have recently been on a dizzying rollercoaster ride, this was primarily triggered by the global Covid-19 pandemic, although they were arguably already over-stretched in terms of valuations. Investors and advisers are having to react to what’s happening to their portfolios, as well as the wider implications of a pandemic-induced recession for millions of workers, businesses and government finances. And like millions of other people, they are adjusting to online meetings and working from home with mixed results.
Further investment repercussions of the pandemic will probably emerge over time and we will be looking out for them. In the meantime, we should try to bear in mind the prevalence of confirmation bias when we look at how investment decisions are made in the light of the Covid-19 pandemic.
*To find out more about the CoreData Volatility and Communications Study 2020, or our next study on the impact of Covid-19 on financial advisor business models, contact Craig Phillips, head of international at CoreData, [email protected]