A series of disconnected “incidents” over the last three months has convinced me that I needed to address the issue of family education again. These “incidents” related to conversations with families, individual investors, and asset managers, together with the multiple stimuli to which each and every one of us is subjected daily. While, in fairness, the topic at hand should in fact be a concern for any family, be it wealthy or not, there are reasons to believe that it is at least as relevant to wealthy families. After all, children of these families are or will eventually be called upon to make important decisions. Their ability to get these decisions right will impact not only their own destinies, but also those of their descendants.
The issue principally revolves around a seemingly decreasing ability to make fact-based decisions and, in a related manner, to distinguish between facts and opinions. Ostensibly, it is nothing other than sad to think that such a generic skill would need to be isolated and discussed at this time. One would think that it should have developed over time, taught specifically and by osmosis by educational institutions and families themselves. However, a number of factors have conspired to make a specific and dedicated effort necessary. Three stand out, though there are many more, and readers should note that this is not written with a sole focus on the US but rather reflects a situation that seems more or less prevalent through most of the non-Asian developed world:
(1) Communications which used to take thoughtful and at times detailed forms gradually evolved into sound bites and then simple tweets. How does one communicate a difficult concept in a sound bite lasting six seconds or less or with a tweet limited to 280 characters? In fact, “the most common length of a tweet back when Twitter only allowed 140 characters was 34 characters. Now that the limit is 280 characters, the most common length of a tweet is 33 characters. Historically, only 9% of tweets hit Twitter’s 140-character limit, now it’s 1%” according to Sarah Perez of TechCrunch!
(2) Political correctness—though in certain cases a welcome filter—has effectively served to shield most people from honest discussions about disagreements. Whether one should look at high school or colleges, the prevalence of prohibitions of any form of situation that could cause any party any discomfort is preventing young people from getting to know both what it is to be confronted with a valid contrary logic and to have to resolve a conflict of opinions through a sensible, measured process rather than immediately resorting to anathema or “labeling.”
(3) The extreme politization of everyday life events has led to a blurring of the line between facts and opinions. Whether one focuses on economic policy, social change, climate issues, the efficacy of vaccination, or a number of other reasonable debates, it is striking that one is hard pressed to see a real dialog. One side postulates some view and any discussion of that view is almost always based on ideology rather than facts. Behavioral science teaches us that there are multiple issues of framing or even the faulty use of statistics that can present a case in a way devoid of all reliance on fairness and honesty.
I will use one example—which I will try to keep generic enough to make sure that no one is offended—to illustrate how such an environment can lead to decisions that can at times have a dramatic impact. A few years ago, a new medication was proving quite effective at helping sufferers of an unfortunately broadly spread disease lead a normal life. For some reason it was further tested, and it was proven—within the limits of experimentation—that it raised the risk of another disease developing from 0.001% to 0.002%. One can describe these findings with two—equally true—headlines. The first states that the medication doubles the risk of developing another condition. The second states that the impact of the new medication on the risk of another disease is minimal. Though equally true, are the two potential headlines equivalent? In fact, the focus was placed on the first formulation and the medication was removed from the market.
What does this have to do with managing family wealth? I would argue that it has a lot to do with it in the sense that the kinds of decisions made in such a distorted environment do not lend themselves to success. Consider a fact: most, if not all, of the major equity or bond market crises that have taken place over the last 50 years arose in large measure because “conventional wisdom” had been discarded, to be replaced by a “new paradigm.” This applies to the Hong Kong property market in 1982, Japan in late 1989, the tech bubble in the US in 2000, to the “great recession” of 2008 and its disregard for irresponsible borrowing and lending and many others. In all these instances, a focus on fundamental data was abandoned “because things were now different.” Yet, consider how much wealth was lost at those times, particularly by those who bought into the new paradigms without fully understanding the consequences and thus bailed out of their losing positions before many had a chance to recover.
What are three important elements of making successful decisions?
(1) Clarity of architecture: One’s decision process—a systematic model or a more qualitative alternative—must be clear as to how it expects various elements to come together to make for reasonable and repeatable decisions. Do I know what I believe is causing A to become B and is that belief supported by theoretical and empirical evidence? Any model that would not have worked in the past has little or no credibility claiming that it can forecast the future, unless one can point to a specific structural change, with some theoretical or empirical perspective to justify the impact the change is assumed to have had on previous relationships. Does a majority of the population understand this?
(2) Clarity of assumptions—or hypotheses: Any form of decision affecting the future must, by necessity, be based on a number of assumptions as to how the key elements that are expected to drive events will perform. Can I spell out what these assumptions are and express how differently—or similarly—they are expected to behave relative to the past? Any dramatic change between future expectations and past outcomes ought to be clearly addressed and explained. Simply postulating a dramatic change in the behavior of one or several assumptions without having to explain why it should take place is a recipe for getting to a foregone conclusion. Can good intentions lead to unintended effects?
(3) Clarity of perspective: Even in the context of a well-constructed decision process, one is always subject to the natural limitations in forecasting ability. After all, models are created because reality is too difficult to replicate. Thus, any reduction of the dimensions or the complexity of any problem introduces a limit to one’s forecasting ability. Do I know the real limits of my forecasting skills and potential, and do I therefore present my conclusions with the appropriate level of humility? It is often ridiculous to impose massive change—with its monetary, psychological, practical, and human costs—when the predicted outcome is hardly more than a 50/50 proposition.
The current college-age generation, as well as the one that preceded it, have had a unique experience in that technology and the knowledge that it permits have led to a quantum leap in making information readily available to many more people. Yet, a crucial piece of wisdom seems not to have been taught: the progression between data, information, and insight. Information is organized data; insight is processed information. This presumes that the data are known and clearly presented, that the organizing principles leading to its becoming information are valid, and that the way the information is processed is reasonable and recognizes the multiple traps our minds can set up for us. People need to be taught the fundamental tenets of behavioral science—and, in the wealth management world, of behavioral finance—so that they understand all the tricks which their minds are likely to play on them: narrow versus correct framing, fast versus slow thinking, naïve probabilities versus absolute observations, momentum versus contrarian thinking, and several other natural biases. Though this might not make the world any more fun and might even create discomfort—the old “do not bother me with facts, I already have opinions”—it has the potential to improve the success potential of the decisions they make.
In short, one should learn to take the time to distinguish between the world as it is and the world as we would like it to be and make decisions based on solid processes, reasonable and clear assumptions, and a humble enough perspective that gives honest odds to a decision being wrong. Diversification is not dead!
The Summer 2019 issue of The Journal of Wealth Management is harder than our last issue when it comes to grouping articles. Indeed, we may actually have more variety than we have seen in quite some time.
The first two articles relate to a technical aspect of investment management: smart beta. While a few people could convincingly argue that the issue is too specific to investment matters for a journal such as ours, I actually think it fits very well. The logic guiding me in that decision is that smart beta is a topic which has been on many lips. Thus, in the light of earlier comments on the need for all—ergo for our readers as well—to have complete information, it seems to me that we need to clarify the topic. That way, readers will avoid the risk of falling in the trap of working a term which is often not used in the narrow sense in which it should be. The first article is by Edward Chang, Thomas Krueger and Cedric Mbanga and posits that, unlike index funds, smart beta mutual funds attempt to beat the market by weighting securities based on some factor, such as price, value, momentum, and others and concludes that they do not necessarily outperform the market, as measured using category averages, though performance can be greatly improved by selecting funds that charge less for their services. The second, by Francesc Naya and Nils Tuchschmid focuses on a slightly different topic of Alternative Risk Premia; these are rule-based strategies designed to reward investors exposed to non-traditional systematic risk factors; the authors conclude that not all strategies capture the risk factor they claim to aim to capture, as performance is dependent on making the choice of an index an important component of the allocation process.
The next article effectively is a category by itself. Jürgen Vandenbroucke and Gosia Fortuna use data from an existing classical risk-based questionnaire to define subgroups of investors that are expected to exhibit a different attitude toward loss and conclude that investor profiles should be based on a combination of risk and latitude vis-à-vis losses, rather than the usual risk profile.
Our next three articles adopt a common focus on commingled investment vehicles. Though they do possess a strong focus on investment issues, each brings in some new light on non-pure investment aspects of the challenge. The first, by frequent contributor John Haslem, provides mutual fund shareholders with a normative listing of transparent and traditionally opaque fees and expenses designed for almost most all funds, an analysis which is needed because a large percentage of individual investors, especially those with low financial literacy, are unaware of the existence of traditionally opaque fund fees and expenses, no less their percentage costs. The second, by Bernadette Ruf, Nandita Das, Swarn Chatterjee, and Aman Sunder looks at socially responsible mandated mutual funds and argues that dramatic growth during the last decade makes it important to understand how their social metrics (environmental, social, and governance; ESG) relates to their financial performance, concluding that funds performed better relative to the broader market, when equity price increases were modest, and vice versa. The final article in this group is by Prakash Dheeriya and Rama Malladi and suggests the idea of an exchange traded fund focused on companies that cater to children, constructing and comprising 39 companies, comparing its performance with that of S&P 500, and concluding that this index can serve as a good investment tool for financial advisors and investors alike and be used in advancing financial literacy among parents.
Our next two papers fall under a security analysis theme, with one in particular looking at India, a focus that has been important to us in the last several years: increase the knowledge of global investors of what happens in selected developing countries. The first, by Rajesh Kumar, aims to determine the fundamental drivers of various relative valuation multiples in different industry sectors concluding that long-term growth and dividend payouts are important determinant variables for PE multiples, the reinvestment rate is the major determinant of enterprise value to book multiple, while net profit margins and dividend payouts are the determinant variables for a price to sales multiple. The second, by Ritesh Patel, aims to measure the effect of merger announcements on the wealth of shareholders of bidder banks, target banks, and combined banks, adding to the knowledge about wealth effects of merger announcements and the influence of the type of merger in the Indian context.
Our final paper again stands on its own. It is authored by early contributor Olivier Mesly and his PhD student Olivier Braun. It focuses on project management issues, reporting the key criteria in ensuring project management success and proposes the creation of an emergent model following the guidelines associated with grounded theory. While the focus on the corporate scene may at first appear off in our journal, readers are invited to consider how these skills can be applied to the context of family office and wealth management in general. In fact, we invite potential authors to take that topic on and extend the insights provided by this paper more directly to the wealth management world.
Jean L.P. Brunel
Editor
- © 2019 Pageant Media Ltd
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