Many wealth managers are using behavioural finance to strengthen portfolio management and better understand clients’ risk thresholds. Valentina Romeo talks to Barclays’ head of behavioural finance, Dr Greg Davies, to understand what the method’s future holds and if it could be a real differentiator for banks
Wealth advisers have increasingly made use of behavioural finance tools to boost client retention, enhance investment performance and rebuild clients’ confidence.
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Behavioural finance uses social, cognitive and emotional factors to understand the economic decisions of investors.
Major banks around the world have heavily invested in incorporating these tools into their portfolio offerings and started training their advisers to account for behavioural biases when advising clients.
Barclays has been a pioneer of behavioural investing – having launched the division in 2006 – substantially ahead of any competitors who were moving in the same direction.
"We use a mix of behavioural and classical finance techniques, we bring them together and try to design tools and systems that allow us to connect clients to a solution that is optimal both for their financial needs and also for their emotional needs," says Dr Greg Davies, head of Behavioural Finance at Barclays Wealth & Investment Management.
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By GlobalDataAccording to Barclays Wealth’s Insights report on behavioural finance, more than two-fifths of high net worth individuals (HNWIs) wished they had more self-control over their financial behaviour by following stricter investment strategy rules.
The report suggested HNW investors with more than £10 million ($16m) had the greatest desire for financial discipline.
The report also said emotional trading can cost investors up to 20% in returns over a ten-year period and HNW investors, who used a rules-based strategy to investments, had 12% more wealth on average than those who did not use rules.
Davies says that since the Financial Conduct Authority (FCA) changed to Financial Services Authority (FSA), the UK regulator has put behavioural economics at its heart, as it focuses on conduct risk.
"The outcomes for clients are based on decisions they would make and those are influenced by the regulatory environment, but also by how we as a bank design product and present it to clients," says Davies.
The behavioural financing tools increasingly serve the entire range of Barclays’ clients, from the retail to institutional side. However, the bulk of Davies’ and his team’s work is around HNW and UHNW advisory and discretionary solutions.
Barclays’ behavioural finance framework contains data on individuals based around six different dimensions of financial personalities for over 40,000 HNWIs in Asia, America and Europe.
Furthermore, Barclays’ behavioural finance tools are built into a range of segments – from the asset allocation modelling approach all the way through to the design of the user interface of its self-directed service system.
Going over the surface
According to Davies, behavioural finance is certainly a differentiator for private banking and wealth management firms, and could increasingly gain traction.
"Ultimately good investing is about taking consistently good decisions over time, and this cannot be achieved without considering the behavioural aspects of decision making," he says.
The evidence is very clear that investors forfeit returns through their perpetual need to do what feels momentarily comfortable, rather than what is right for the long term, Davies adds.
For Davies, the main difference between Barclays’ approach to behavioural finance and that of other firms’ is the total integration of the tools into the bank’s IT systems, to make it part of the business proposition instead of an add on.
The philosophy behind behavioural investing is key to identifying the "behaviour gap", Davies explains. Technically, it is the difference between actual investor returns and the returns an investor might have achieved had they doggedly adhered to classical principles.
Davies also stresses that the position of behavioural finance is more sophisticated and deep rooted.
"We can’t turn off our emotions and intuitions about the market. What we can do is figure out how to make sure that the comfort we need is planned in a thoughtful and efficient way rather than get it in an unplanned and expensive way.
"Don’t let the best be the enemy of the good," he says.
Current trends
The most important factor is to put your money to work, diversify it and invest it for the long term, advises Davies.
"If you put aside cash over time it will, on average, be at the expense of a foregone yield of around 4-5%. At times when anxiety is high, this can be substantially higher. In the last few years, investors in equities not only earned a risk premium but also an anxiety premium," he says.
Davies says over the last 18 to 20 months, things have slightly changed because markets have been improving and thus easing investor worries. However, he says people are still under-confident and uncertain about their long term needs.
He says: "Currently, we are in a fairly balanced space. I think people are looking at risks around the world, and that is making them nervous. They are also aware that they have missed out on a lot of the upside over the last four and a half years and that has filled them with regret."
Making money behave
Though behavioural finance is often seen as a "fill in some of the gaps" service, its improvement could make a concrete difference for banks.
"Behavioural finance is not an instant panacea for bad decisions, and it does not enable us to make everyone a great investor. It will also not prevent future cycles of boom and bust.
"However, used effectively, it can certainly help individuals, families, companies, or even whole countries to better govern their knee-jerk responses, and therefore make better and less emotionally driven decisions over time," Davies says.
Behavioural finance does have limits, and is only as good as the effectiveness and sophistication of how it is used, Davies adds, saying, "There is use of the terms and language of behavioural finance today. Many wealth managers talk about it, or put together lists of behavioural biases, behavioural anecdotes in their client communications."
However, if wealth managers genuinely consider personality traits and emotional needs in how they service individual clients, as well as ensure that this is thoroughly embedded into their systems, processes and propositions, investors will "more reliably get the right answer", Davies explains.
