Do investors learn from crises? Finance Professor Teodoro Cocca talks about the impact of the last more than a decade of crises on the behavior of private banking clients – and what he advises private investors and banks to do now.
Professor Cocca, you have been conducting a scientific study on behalf of LGT on the investment behavior of high-net-worth private investors from the time of the 2008 financial crisis until the 2020 corona crisis. What have private investors learned from these crises?
Investors indicate that they have taken a more critical stance towards banks and relationship managers as a result of the 2008 financial crisis. They also say that they have refrained from making investments that they did not understand or that they understood too little. And they have tried to become more financially literate and make investment decisions based to a greater degree on facts ...
... Those are ambitious goals. Have they succeeded?
Things haven’t really changed. Financial literacy has not improved since the financial crisis. This points to a gap, a demand for knowledge, that has not been met. However, raising the level of knowledge is especially important for investors with low financial literacy. Generally speaking, there is still a lot of potential in this area.
Private investors said that stocks are overvalued. However, your comprehensive study shows that investors have nevertheless held on to equities. How do you explain this?
Investors are in an “equities dilemma”, in a manner of speaking. They feel trapped. Trapped between the fear of missing out on the only asset class that could offer substantial returns and the concern that stock markets are overvalued.
The level of knowledge about an asset class determines whether an investor will invest in it.
So the private investors surveyed saw no asset class that could generate substantial returns other than equities?
Exactly. And they decided to stay invested in equities. But they did so without much conviction.
But alternatives to equities exist, for example alternative investments such as private equity. The advantages of this asset class have long been proven and it has become the norm for institutional investors. Private investors don’t seem all that interested. Why?
Financial literacy, or rather a lack thereof, plays a major role here too. Our surveys show that the level of knowledge about an asset class is one of the factors that determines whether an investor will invest in it.
Speaking of financial literacy: in addition to diversification across asset classes, geographical diversification also improves the characteristics of a portfolio. How well are the investments in the portfolios of the private investors diversified geographically?
Not well, unfortunately. Our figures confirm a well-known phenomenon, and to a high degree. The home bias is pronounced: Swiss investors invest an average of two thirds of their portfolio in Swiss equities. From a historical perspective, little has changed in this respect. This strong home market orientation is also high in Germany and Austria, albeit somewhat less so than in Switzerland.
Why is this a problem?
International diversification reduces portfolio risk. This is undisputed. Private investors don’t make enough use of this potential, and the same applies when it comes to investing across various asset classes. Private investors still limit their investment universe to equities, bonds and cash. Alternative investments remain on the sidelines. As a result, investors are missing out on opportunities.
Do private investors pay a price if they don’t apply these findings?
Scientifically sound long-term observations clearly show that alternative investments – private equity is just one example thereof – improve the risk/return profile of a portfolio. I would therefore recommend that private investors look at how managers of very large assets – investors whose investment horizon is very long-term – invest their capital.
Such as the endowment funds of private American universities or substantial family assets?
For example, yes. These investors all hold a number of different asset classes, including alternative investments, in their portfolios. Both the scientific evidence and the experience and performance of these professionally-managed assets suggest that private investors are well advised to familiarize themselves with this concept.
Sustainable investments are receiving much more media coverage than in the past. Does this reflect their greater importance in the portfolios of high-net-worth private investors?
No. Sustainability is not yet popular with private investors. On average, five percent of their portfolio is invested in sustainable investments. There is obviously a huge discrepancy between the media coverage and social relevance of the topic, and its thematic implementation in the portfolios of private investors. The level of investment in this segment has fallen well short of expectations.
What role do banks and relationship managers play in the fact that sustainability remains a peripheral topic?
The banks have not, or not yet, succeeded in convincing a large share of clients of its merits.
What do you attribute this to?
Financial literacy plays an important role here too. Private investors want more relevant information, for example on impact investing or microfinance. Also, a number of respondents have the impression that sustainability is simply a label used to sell them products. This poses another dilemma for clients. They want to invest in sustainable investments, but they haven’t fully bought in to the concept.
In the long term, the returns generated on sustainable investments are better than for conventional investments – or at least not worse. Scientific studies show this. Are investors aware of this fact? No. The belief that sustainable investments mean foregoing returns prevails. Many investors think that it comes down to opting either for sustainability or returns. But this contrasts with empirical findings. Recent studies show that sustainable investments are actually linked to higher returns. This is another area where knowledge transfer and training is required. The first step is to deepen knowledge, in order to be able to talk to clients at the product level in a second step. There is clear potential for improvement in this area. I’m convinced that great progress can be made here.
Investors are considered irrational beings. Has this been confirmed during the crisis?
What does irrational behavior during the corona crisis mean? It’s hard to say when you’re in the midst of a crisis. Only in retrospect will you be able to better assess that. But if we take classic patterns of behavior as a starting point, we can say that private investors have actually behaved very sensibly.
How has that manifested itself?
Investors didn’t panic, they didn’t buy or sell equities in haste. Most investors did nothing at all. They stuck to their long-term strategy. Those who were active bought at lower prices. From today’s perspective, the latter was not the stupidest thing to do. All in all, reason, calm and rationality prevailed. I didn’t see any classic patterns of irrationality.
What advice do you give to investors based on the results of the study?
Invest now, namely in your financial literacy! That’s the most important thing. And it applies to most investors. Investors should ask their bank and relationship to share knowledge with them. That is what they are there for. And both benefit when investors’ financial literacy is higher. I also advise investors to stick to their strategy. They did this well during the corona crisis, which is more difficult than it might seem. Perseverance will no doubt be put to the test in the coming months, as the financial markets will remain turbulent. And finally, diversify your portfolio. Take advantage of the benefits of asset diversification!
Pictures: Daniel Mikkelsen
Under the leadership of Prof. Teodoro D. Cocca, the Department of Asset Management at Johannes Kepler University in Linz in January and February 2020 conducted the sixth survey since 2010 on the investment behavior of private banking clients in Germany, Austria and Switzerland. The main criterion for participation in the survey was disposable investment capital. In Germany and Austria, the minimum disposable investment capital was EUR 500 000 and for Switzerland, it was CHF 900 000. Due to the effects of the corona pandemic on financial markets, a follow-up survey was conducted in April 2020 with the private banking clients in Switzerland who had already been surveyed in January by the LINK Institute.
Teodoro D. Cocca is a Professor of Asset and Wealth Management and a member of the Research Institute for Banking and Finance at Johannes Kepler University in Linz, as well as Adjunct Professor at the Swiss Finance Institute in Zurich. He also advises financial institutions on strategic matters. Prior to this, he worked for Citibank, the Stern School of Business in New York and the Swiss Banking Institute at the University of Zurich.