Tutorial 5

Question 1

1. How and to what extent can investment advisors/portfolio managers attempt to add value? How should Rudy Wong advise Bob Miller and the Kleins? Discuss with the lens of “behavioural finance”. [50 marks]

Introduction

• Context about the problem
• need to advise Bob and the Kleins etc.
• Why the lense of behaviour finance is important

Body

• How can Rudy Wong add value to his clients DONE

• What kind of value is Rudy Wong adding DONE

• Contents - need to advise bob and Jackie

• What type of behavioural biases they are exhibiting

  • What type of behavioural finance does this fall under

• Appropriate recommendations for their biases

• Use historical data to support views

• discuss with the lense of behavioural finance

• What kind of investment strategies could Rudy Wong use to approach the Millers and Kleins?

• Advantage/disadvantage of strategies

• Active and passive ways for security selection

Conclusion

Question 2

2. How confident should Rudy Wong be as to the advice he provides to clients? Given the poor performance in the previous year (as of the time of the case), how do you think Wong should best approach such situations?

• introduction, key concepts (what are the challenges faced by advisors)
• Summary of arguments
• poor performance in previous years
• Briefly outline the approaches Rudy Wong could take

Second part - ideas

• focus on Rudy wong, advisor
  • Transparent communications, etc.
• Rational perspective, historical data
• Importance of emotional factors - validate clients concerns, consider emotional approach
• Provide a logical explanation for everything
• Provide clear evidence

Notes about Bob Miller:

Loss Aversion: Bob shows a tendency to fear losses more than valuing equivalent gains. This is evident in his strong emotional response to market downturns, where the fear of losing money drives him to consider moving away from equities and toward more stable, lower-risk investments such as bonds

Recency Bias: Bob is likely influenced by recent market performance, focusing heavily on the current volatility rather than considering long-term market trends. This bias causes him to overreact to short-term losses, making him question the overall strategy of staying invested in equities

Herd Behavior: Bob's anxiety may be exacerbated by observing the behavior of others during market downturns. When investors around him are panicking and selling off assets, he may feel pressured to do the same, even if it contradicts his long-term financial plan

Overconfidence: While Bob is primarily risk-averse, he may exhibit overconfidence in his ability to protect his portfolio from losses by shifting assets in response to market conditions. This is a subtle bias where an investor believes they can time the market better than the evidence suggests​

Illusion of Control: Miller seems to believe he can improve his portfolio’s outcomes by making his own trades, particularly by considering drastic actions such as pulling his money out of equities during the downturn. Wong worries that Miller underestimates the risks of doing so. This is a common behavioral finance bias where investors feel they have more control over uncertain outcomes than they actually do.

Confirmation Bias: Despite Wong’s warnings about the volatility of Canadian oil and gas stocks, Miller insists on maintaining a large allocation in them. He may be seeking out information that supports his existing belief in the long-term profitability of these stocks, while ignoring warnings or contradictory evidence about their risks during volatile market conditions.

Framing and Loss Aversion: Miller’s fear of significant losses and his emotional reaction to market downturns show a tendency toward loss aversion. He weighs the potential for loss more heavily than potential gains, which is typical of investors who focus more on avoiding losses than achieving gains, even if staying invested may lead to better long-term outcomes.

Representativeness Heuristic: By favoring oil and gas stocks, which he likely associates with strong past performance or perceived long-term potential, Miller may be relying on stereotypical judgments about these industries rather than a nuanced analysis of their current volatility and risks.

Anchoring: Miller may be anchored to his initial judgment that Canadian oil and gas stocks are a strong investment and is slow to adjust that view, even when faced with evidence of their cyclical volatility.

Jack and Kelly Klein

Loss Aversion: Jack and Kelly became nervous when stock prices dropped sharply, which suggests they were more sensitive to potential losses than to gains. Loss aversion occurs when investors disproportionately fear losses, even if they are invested in a long-term strategy that is expected to deliver growth over time. This is a common bias in volatile markets.

Recency Bias: Their anxiety about the market downturn may stem from placing too much weight on recent events (the sharp drop in stock prices) rather than the historical performance of equities. Recency bias causes investors to focus on recent trends, sometimes overestimating their long-term impact.

Skepticism or Distrust of Expertise: Wong recognized that the Kleins might perceive his advice to buy more equities during the downturn as self-serving ("seeking to gather more assets under management"). This reflects a potential framing bias or distrust of expertise, where clients question the motives of financial advisors, even if the advice aligns with long-term rational strategies.

Status Quo Bias: The Kleins may prefer to stick with their existing asset mix due to a tendency to resist change, even when there is a compelling argument to alter their strategy. Status quo bias leads investors to avoid making changes, often because of uncertainty or discomfort with new strategies, even if those changes might be beneficial in the long term.