Unfortunately, as humans, we are poorly neurologically wired to be good investors. Our brains promote survival instincts - such as fight and flight, fear and greed and an aversion to losses – help us to survive but can lead us into bad investing ways. For many investors a propensity to place too much weight on recent events in terms of what the future may look like is quite common. This is known a ‘recency bias’. Charles Schwab, a major US broker, sponsored some research on its own client base to identify which behavioural biases predominate in their clients and recency bias was the one most commonly exhibited . Around 50% to 60% of all investors appear to suffer from recency bias, and the number is even higher for younger investors, possibly due to the influence if social media.
The death of the office
Let’s look at an example of recency bias in action. Some investors may include global commercial property (e.g. shopping malls, offices, industrial buildings, logistics hubs and data centres) in the growth assets portion of portfolios to provide a bit of diversification to their pure equity exposures. It is not guaranteed to work all the time but can be beneficial at times.
The logic and empirical data supports a reasonable case for inclusion. Yet, of late, global commercial property has been under pressure on account of lifestyle and work-pattern changes, driven in part by covid lockdowns. Add in rapidly rising interest rates and the ‘story’ sounds quite bleak.
In 2022 the asset class was down by around -14%, whilst the UK equity market was up by about +7%. It is down again in 2023. Some may be tempted to consider abandoning it as an asset class, as the future ‘obviously’ looks bleak, and its recent run of poor performance is thus likely to persist. Yet that is to ignore a central tenet of systematic investing that all this doom and gloom is already reflected in market prices for global commercial property. It may go higher or lower from here, not because of what has recently happened but what new information the market receives. Take a look at the chart below.
Figure 1: Every asset class has its bad and good periods (rolling 10-year returns)
It is evident that each of the three asset classes has had better and worse times and - over this period - global commercial property has been the most consistent. A rational investor might reasonably want to own all three asset classes in some proportion. Abandoning or adding to a portfolio simply by extrapolating what has recently done well or badly is not a great strategy and is likely to lead to constant portfolio change, less-well diversified portfolios and poorer outcomes.
In 2022, commodity futures – after many very poor years – were the star asset class in a year when bonds and equities were down, returning around +30%. In 2023 they are down around -15%. When gold rises in price, investors’ interest is always piqued.
If thinking that the recent past somehow presages future outcomes and picking what has just done well and avoiding what has just done badly, is a winning strategy, then investors who follow this path are likely to be disappointed.
Perhaps reflect a while on these wise words written by Charles D. Ellis in his excellent book Winning the Loser’s Game (Ellis, 2002):
Ellis, C. D. (2002) Winning the loser’s game, 4th edn. New York: McGraw Hill.
‘The hardest work in investing is not intellectual, it’s emotional. Being rational in an emotional environment is not easy. The hardest work is not figuring out the optimal investment policy; it’s sustaining a long-term focus at market highs or market lows and staying committed to a sound investment policy. Holding on to sound investment policy at market highs and market lows in notoriously hard and important work, particularly when Mr. Market always tries to trick you into making changes.’
