This is what the Financial Conduct Authority (FCA) found when it recently rounded up 1,000 investors, of whom at least half manage portfolios worth £100,000-plus, to participate in a study into why so many investors disregard the damage done by high charges, and shrug off the evidence that the highest-charging active funds do not necessarily achieve better net returns.
The experiment, the aim of which was to reveal ways in which active managers could be made to focus customers’ attention on charges rather than diverting it away, and to make them compete on price, something they currently don’t do, presented the cohort with a choice of UK equity funds, some cheap, some expensive. Some funds were presented with less visible warnings about charges, and some came with stark warnings positioned prominently and accompanied by a chart comparing the fund’s costs with those of its competitors. This type of warning proved partly effective at altering investors’ behaviour, with a number actually changing their mind about the fund they had selected. But the FCA found that even when increasing the focus on charges, it did not reduce the importance that investors placed on other characteristics such as performance. Ultimately what made investors’ choice for them was performance. But charges can cost investors thousands of pounds.
All of these same investor behaviours can be mapped over onto share selections: boilerplate warnings and camouflaged problems compete with a good story and management spin. And even when you can spot the clues to danger ahead (for example, as Christopher Boxall suggested last week in his Key to Aim Success piece, by reading the “exceedingly boring” admissions document) – it can still be hard to resist our cognitive biases.
In our cover feature this week Robert Merrifield, an experienced former investment manager, explains how he fell for a 'story', and more than once. Our columnist John Rosier, another experienced investor, is kicking himself over his own complacency with regard to Conviviality.
In a previous article Robert Merrifield recommended that investors should always check for three key pillars of support: a good story, good valuation and a strong technical case. If one of those pillars is weak you are taking a risk, and if one is negative you are taking excessive risk and it’s time for a rethink.
All investors make mistakes, whether it’s not paying enough attention to the 'three pillars', missing or ignoring the risks, falling into a dividend trap, being slow to sell, not making sure we understand what we’re buying, and following the crowd. Not re-evaluating is another error. What matters is that we learn from them.
All investors need a plan for protecting themselves against losses and it should start with not just analysing companies but with analysing our own behaviour too.
