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Posted by Purpose Investments on Apr 19th, 2020

How to Use Behavioural Finance to Combat Stress, Focus Long-Term and Find Opportunity in Crisis.

The combination of on-going physical isolation and extreme market uncertainty is a perfect recipe for panic investing and short-term decision making. The current bear market and looming possibility of a global recession naturally trigger stress for advisors and investors, but there are strategies we can utilize to address our own behaviours and stay focused on how to win long-term.

As Craig Basinger, Chief Investment Officer at Richardson GMP, tells Purpose Financial founder and CEO, Som Seif, “We’re wired to react and protect, which serves us really well in the general world but really hurts us when it comes to investing.”

Listen to their full conversation to learn more about:

  • Using behavioural finance principles to spot biases and make investment decision based on data, not emotion
  • Why you have to confidently invest in areas of opportunity despite uncertainty
  • The increased importance of proactive communication and constructively debating your own ideas during times of isolation
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Read the transcript:

Hi everybody, it’s Som, founder and CEO of Purpose Financial and Purpose Investments. Again, I’m here isolating with my family and hoping all of you are safe and secure wherever you are.

Although we’ll likely have a stay-at-home order for several more weeks, the data is showing much more promising information. We’re walking out of the forest now, in my opinion, rather than into it, and that’s a really important thing when it comes to the pandemic.

Now, we’re still uncertain of what we’re walking into economically, but at least on the social and health issues, which we’ve all worked so hard to support, we’re on the other half of this. But there’s still lots left to do.

As I’ve adjusted to managing our businesses during this unique time, I’ve tried to create some healthy new habits for myself while I’m at home. I’m a big believer in the power of micro-habits to contribute to long-term change, and I’d really recommend Atomic Habits by James Clear to anyone looking for a great book to read on this. Since January, I’ve been meditating. Since I’ve been home, I’ve created a challenge for myself that I had to meditate every day until we can go back to work. I’ve done it now for 30 days straight, I’m enjoying it so much and it’s been really great for my mental state during all of these heightened periods of stress.

Over the past few weeks, we’ve had really great discussions at timely moments around discipline in your investment decisions, being very thoughtful about why you’re making decisions, and perspectives for advisors and how they can make their clients think differently during this time.

We had Sandy Liang come in to talk about taking advantage when the odds are on your side and the opportunity to win is there, and last week we had Barry Morrison who talked about his more than 50 years of experience and what that’s taught him about investing during these panic periods.

Today, I wanted to talk with my good friend Craig Basinger. Craig is the Chief Investment Officer at Richardson GMP where he heads up the asset management division. He also sub-advises on three of Purpose’s funds, and we’ve had a great experience with one of those funds recently: The Purpose Tactical Asset Allocation fund, which has just had an unbelievable year and performance relative to this market.

Craig has a really unique perspective and has become a major student of behavioural finance, which is essentially the study of individuals’ behaviour and how they impact markets themselves. It’s an area I’ve always been fascinated with and that I’ve spent the past decade of my life learning about. It’s all about the principles that are pre-baked into the markets because of how the emotions of the individuals who drive the markets ultimately make them move up and down. The FOMO of when things are going really well, the panic of the difficult times, and all of those associated biases.

Craig, I’m really happy to have you here and I was hoping you could give us some perspective, for advisors and investors, on how they should be thinking today.

Thanks, Som. I would certainly echo your book recommendation as well.

The environment we’re in right now is certainly very emotionally charged, for all of us. Obviously, we’re all concerned with the health of our loved ones, and the health of everyone actually. We’re fighting this pandemic with, by far, the best tool we have, which is isolation.

When you put all that together it creates a very stressful environment for all of us. Then you add on a very volatile bear market and a likely global recession and emotions are elevated, there’s no question.

This scenario dramatically increases the likelihood of making behavioural investment mistakes. “Availability bias,” which is a prominent one in this kind of market environment, causes us to focus disproportionately on really vivid events, like the news out of Italy or New York a few weeks ago, or the mass unemployment numbers coming out now.

This also relates to “recency bias” where we really get focused on the short-term and what’s happening today. The problem is with all these emotions running high they can easily lead us to overreact and make short-term moves. Both good and bad. There’s also a distinct possibility that the fear of missing out is making people rush into this recent rally that we’ve seen off the bottom.

The fact is that we’re wired to react and protect, which serves us really well in the general world but really hurts us when it comes to investing. We believe the market overreacted to the downside in March, and very well might be overreacting to the upside now. While it may not feel like the right thing to do, most often not reacting to the day-to-day is one of the best ways you can start to control your risk of making a behavioural mistake.

It’s really fascinating because I  agree that the markets had a pretty aggressive reaction in March, and we’ve seen some pretty amazing bouncing off the bottom into the first two weeks of April, which I think is up almost 12% month-to-date, which is pretty unbelievable when you think of all the unknowns and how we’re just getting into earnings season.

I know you’ve implemented a lot of these behavioural principles into the way you invest broadly, and your own disciplines as an investment manager. What are some of the things investors and advisors could be implementing into their own day-to-day portfolio management, and even just personal disciplines into how they should be thinking about their portfolios?

I think step #1 is really trying to think a lot longer-term. The mistakes come when you get too tied up into what the media is saying and the news of the day. This health crisis will end, and the recession will give way to a recovery, and the bear market will be replaced by a bull. If you have that mindset it really opens the door to not overreacting, and also to viewing this kind of market environment as more of an opportunity.

We’ve found that adopting a more systematic approach can really help, even if it’s just for a portion of your portfolio. Systematic and rules-based strategies go a long way in reducing the emotional impact of your investment decisions. Our largest strategy, as Som mentioned, is our tactical strategy. It’s rules-based, and that helped it navigate through this extremely uncertain environment when we really had no idea of which way things were going or how bad it would get. So having a systematic approach certainly helps.

Another thing that really helps is talking about your investment decisions. We’re all isolated right now, physically. But we can still communicate. In isolation, everyone feels they’re more alone than usual and discussing your ideas with others helps encourage contrary arguments and other perspectives. If you’re too myopically focused on one aspect, discussing it with others, whether they agree or disagree with you, can often lead to a better decision.

One of the things we do on a regular basis is that, for every decision we make, we draw up what we call a “pre-mortem” that essentially means before making a decision you consider a whole bunch of different scenarios on why it may work out, which is obviously why you believe in it. But also why it may not work out, and it opens the mind to different scenarios and enables us to have a better decision-making process, which is what we’re trying to improve.

I think having people to bounce your ideas off of, or debate so you can look at a problem multiple ways instead of just having your own emotional perspective, is helpful. I know in mid-March when we saw the major bottoming, that Friday I had sent out a note to friends and asked them to tell me what I was missing about the next two years of earnings from these companies that were down pretty meaningfully, close to 40%.

We all were of the same view that it was a mistake, and it gave me the confidence to say that this was actually a time to be more aggressive.

In moments like this, Craig, when you’re staring at the market and you can’t really see 30 days out, how do you make decisions? You talked about systematic thinking, but what are some things that we can implement that will allow you to make decisions when there’s lack of clarity?

This comes from being a student of the market, and also a portfolio manager in the market, but I think the path forward right now is 100% uncertain. The uncertainties are extremely elevated right now.

But, I’ll be honest, if you wait for everything to become known, and the path to become clear, the market will already have figured that out and there’ll be no opportunity to be had.

I like to remember that, most often, contrarians make money and herd followers do not.

The framework we like to use is that the market is very good at pricing in all of the known information, and it tends to overreact to new information. For instance, today, the market knows that the pandemic data has improved, no question about that. Society purposefully induced a recession to fight a health crisis, so it makes this recession a little bit different. Governments have been extremely supportive, I think probably exceeding most people’s expectations and the economic data is awful and will likely remain so for quite some time.

But what the market doesn’t know is how long it will take for society to defeat this virus, or if it returns later in the year. Whether the economy recovers quickly or slowly. Will the markets start caring about the poor economic data at some point? So far it doesn’t, which is kind of nice, but we don’t know how long that’s going to last.

What we’ve found as a framework to navigate a world of uncertainty is we actually attached some probabilities on the unknowns out there. If you fast forward three months, what is the chance that the health environment and the pandemic data is better or worse? In March that helped us, because it was very bad in March, there was no question, but we had a very strong belief that three months forward it was going to be materially better, which gave us that framework to say “Ok let’s start putting money to work.”

I don’t want to call them “bets,” because they’re investments, but we can place positions that can benefit from a potential improvement. This helps reduce the risk of overreacting to one day’s news, whether it’s positive or negative. Also, if you update your probabilities with the more information you get,  it can really help you have a much more methodical approach that encourages a much more long-term mindset.

It sounds like an amazing framework, and the other part is having great partners to bounce ideas off, which I know you do. Also, it’s really great for us to have you as a partner. Craig, thank you, I really appreciate you taking the time to do this with me today and I know everyone will really appreciate everything you said.