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Volatility and investor behaviour

Published: October 12, 2015 by Ian Jones, Fundhouse

Market volatility, which South Africans have been hit with this year, often causes investors to panic and make irrational decisions. Ian Jones explains how crucial the investors understanding of an investment outcome is in limiting these irrational decisions.

South African investors have been hit from all sides by extreme levels of market volatility this year with volatility in most Global equity markets as well as the South African JSE All Share Index. One can understand why investors are nervous following the year of significant market moves including:

  • The sell-off in emerging markets has seen Global Equities outperform Emerging Market Equities by over 15% over the last year;
  • The sharp decline in the oil price from over $110 a barrel a year ago to less than $50 now (and what that has meant for markets and the Sasol share price);
  • The added volatility introduced by the Rand as it continues to weaken in line with many of the Emerging Market currencies and has now devalued by close to 25% over the past 12 months.

Investor sentiment has also not been helped by all the headlines and comments from the market that tend to add to the turmoil. China continues to feature in the headlines with talk of everything from a slowdown to a meltdown in China, and what that would mean for the Global Economy. The media generally reacts to short term market movements but all the articles do have an impact on the investor’s psyche.

The chart below talks to the through-the-cycle emotions: selling when one is panic stricken and buying when euphoria takes over is a losing strategy.

All the “noise” in the market can start to have an impact on investor behaviour. Fear often drives investors into “panic selling” when the markets start to fall – investors fear losing money and try to get out of the market before the market falls further. Invariably this results in selling into a falling market and missing any recovery that may take place. August was a good example of this – many people were talking of selling equity and moving into “less risky” assets after the market had fallen almost 10%. Trying to time the market and make short term trading profits is a game most people lose.

A perfect example of this behaviour is after the 2008/09 Global Financial Crisis when many nervous investors sold out of equities after the crash and remained in cash while markets recovered.
In our opinion, spending time upfront understanding what investment outcome is needed by an individual helps enormously to deal with emotional investor behaviour when confronted by market volatility. The investment outcome doesn’t only cover the amount of money needed by an individual to meet his requirements but also the time horizon for those commitments. This is the key role of the financial planner and can add significant value to the long term well-being of investors.

Understanding the investment outcome then allows one to construct an investment portfolio with this objective (including the time horizon) in mind. There is a comfort for investors of knowing that a specific combination of asset classes and fund managers have been chosen upfront to fulfil a certain role in a client’s portfolio. When markets are volatile, the portfolio has been built with a time horizon in mind to ensure that significant market movements don’t overly impact the ability of the client to achieve their desired investment outcome. Short term market fluctuations don’t result in a need to alter the portfolios or give into any of the investor behaviour that lead to poor outcomes. It provides investors with confidence to remain invested in an appropriate mix of assets through the euphoria and the panic.