rational investing in an emotional world june - cifps · read a fund’s prospectus before...

© 2010 FMR LLC.552212.1.0

Rational investing in an emotional world

Peter DrakeVP, Economic and Retirement ResearchFidelity Investments Canada ULC

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Important notice

Read a fund’s prospectus before investing. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated. Investors will pay management fees and expenses, may pay commissions or trailing commissions, and may experience a gain or loss.

Any reference to a company is for illustrative purposes only; it is not a recommendation to buy or sell nor is it necessarily an indication of how the portfolio of any Fidelity Fund is invested. The breakdown of fund investments is presented to illustrate the way in which a fund may invest, and may not be representative of a fund’s current or future investments. A fund’s investments may change at any time.

©2010Morningstar research Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or redistributed; and (3) is not warranted to be accurate, compete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future returns.

© Copyright 2010 FMR LLC. All rights reserved. Do not reproduce any part of this presentation without permission.

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3 Bringing behavioural finance concepts to your clients

2 Psychology & investment behaviour

Agenda

1 Emotions and markets: A potent mix

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Fear and greed

An excessive desire to acquire or possess more than what one needs or deserves, especially with respect to material wealth

A feeling of agitation and anxiety caused by the presence or imminence of danger

GREED

Source: Webster’s Dictionary

FEAR

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Equity sentiment roadmap: For a market cycle or a day?

Source: Westcore Funds / Denver Investment Advisors LLC, 1998.

Optimism

Excitement

Thrill

EuphoriaAnxiety

Denial

Fear

Desperation

Panic

DespondencyDepression

Hope

Relief

Optimism

Temporary setback, I’m a long term investor

Wow, I feel great about this investment

Maybe the markets just aren’t for me

POINT OF MAXIMUM FINANCIAL RISK

POINT OF MAXIMUM FINANCIAL OPPORTUNITY

Capitulation

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6,000

8,000

10,000

12,000

14,000

16,000

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

S&P/

TSX

Com

posi

te In

dex

PREmotions matter

Source: Morningstar Encorr as at April 30, 2010.

PANIC/DESPONDENCY

EUPHORIA

S&P/TSX COMPOSITE INDEX PR (2000 – 2010 YTD)

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0

10

20

30

40

50

60

70

80

90

Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10

VIX

clos

ing

pric

e U

S$

The “fear” index

Source: Chicago board of options exchange, VIX Index measuring stock market volatility. As at May 13, 2010 (daily).

Bear Stearns

Lehman Brothers, AIG Merrill Lynch

U.S. elections,Auto industry concerns,Consumer confidence lows

Subprime crisis begins

Concern about sovereign debt, strength of recovery

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The risk of contagion

The communication of disease by direct or indirect contact

DEFINITION:

Asian financial crisis of 1997

EXAMPLE:

Greek debt crisis of 2010 ?

Source: Fidelity Investments Canada ULC.

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Governments went into deficit to fight the recession …

-16

-12

-8

-4

0

4

8

Greece Ireland Spain U.S. Japan Canada Germany

Bud

get d

efic

its a

s a

% o

f GD

P

20082009

Source: Bloomberg consensus for all regions except Greece, December 31, 2009. Greece budget deficit as a % of GDP, 2008: Eurostat, October 22, 2009, 2009: The Wall Street Journal, December 15, 2009. Ireland budget deficit as a % of GDP, 2008: Eurostat, October 22, 2009; 2009: Tough 2010 Irish budget unveiled, BBC News, 2009.

BUDGET DEFICITS AS A % OF GDP

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…Can they get back out?

-28

-24

-20

-16

-12

-8

-4

0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Bud

get d

efic

its a

s a

% o

f GD

P

Greek Deficits as % of GDP

GREECE BUDGET DEFICITS AS A % OF GDP

Source: Thomson Datastream as at March 31, 2010.

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Risk of contagion?

Source: Fidelity Investments Canada ULC. April 30, 2010.

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Risk always exists but not always perceived

WEATHER

POLICY REGULATION

ACTIONS OF A SEPARATECORPORATE OR GOV’T ENTITY

POLITICAL RISK

INVESTOR SENTIMENT

AgricultureCommodities

Financial industryScience

Accounting irregularitiesSovereign debt

Social unrestChanging government

UncertaintyContagion

Source: Fidelity Investments Canada ULC. April 30, 2010.

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Events out of one’s control cause emotional stress

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-8

-6

-4

-2

0

2

4

6

2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2 2009 Q3 2009 Q4 2010 Q1

U.S

. GD

P %

cha

nge

(ann

ualiz

ed)

Is the recovery real?

Source: U.S. Bureau of Economic Analysis. 1st Quarter 2010.

THE U.S. HAS GROWN FOR THREE CONSECUTIVE QUARTERS

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MONTHLY CHANGES IN U.S. PAYROLL EMPLOYMENT

Source: U.S. Bureau of Labor Statistics as at April 30, 2010.

Employment gains lag economic recovery, prolongs negative sentiment

-800

-600

-400

-200

0

200

400

2008 2009 2010

Thou

sand

s of

jobs

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$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Inve

stm

ent v

alue

(200

8$)

Source: Finfacts Ireland, Morningstar Encorr, Federal Reserve Bank of Minneapolis. As at December 31, 2009.

MANY HAVE RECENTLY FLOCKED TO GOLD FOR CAPITAL APPRECIATION

Relying on gold as an anchor in turbulent waters

Gold

S&P 500

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Gold preserves capital over the long term

$0

$0

$1

$10

$100

$1,000

1925 1935 1945 1955 1965 1975 1985 1995 2005

Inve

stm

ent v

alue

(rea

l)

GoldS&P 500Dollar

A $1 INVESTMENT IN GOLD VS. S&P 500 INDEX FROM 1925 – 2009 (ADJUSTED FOR INFLATION)

Source: Finfacts Ireland, Morningstar Encorr, Federal Reserve Bank of Minneapolis. As at December 31, 2009 (annual data).

$4.18

$205.68

$0.08

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Agenda




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Overconfidence

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Overconfidence

90% of drivers say they are above average

How many people here today think they are better than average drivers?

Source: Svenson (1981), Kruger & Dunning (1999).

Question

Answer

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Asset price bubbles through history

JAPANESE PROPERTY

PRICESDUTCH

TULIP BULBINTERNET STOCKS

US RESIDENTIAL REAL ESTATE


Individual expectations can be volatile

OVERLY EUPHORIC WHEN MARKETS ARE GOOD

OVERLY PESSIMISTIC WHEN MARKETS ARE DOWNAs of J

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Mental accounting

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In both cases, you are out $80

Mental accounting – An example

Researchers found that:Most people reluctant to replace the lost ticket (scenario 1)Most willing to spend another $80 to purchase a ticket (scenario 2)

RESULT

Source: Peter Bernstein, 2002.

ConcertBought $80 ticketLost the ticket

SCENARIO I

Would you buy another ticket?

ConcertHave $80 cash to buy a ticketLost the cash

SCENARIO II

Would you still buy a ticket?

The only difference between the two scenarios in how you “mentally account”

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Money is treated differently dependingon its how it is obtained

MENTAL BUCKETS OF MONEY, EACH TREATED DIFFERENTLY

INHERITANCE ANNUAL BONUS MONTHLY BONUS

TOTAL SAVINGS

Source: Beyond Greed and Fear, Hersh Shefrin, 2007.

?

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Prospect theory or loss aversion

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Prospect theory: Losses have more impact on investor emotions than gains

Source: Kahneman & Tversky’s (1979) “Prospect Theory: An analysis of decision under risk”.

Starting point

LOSSES GAINS+ $100

- $100

Losses found to have 2.5 x the impact

of an equivalent gain

POSITIVERESPONSE

NEGATIVERESPONSE

Investment losses and gains

Inve

stor

em

otio

ns

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-100%

-80%

-60%

-40%

-20%

0%

20%

40%

Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 Dec 09Act

ual &

per

ceiv

ed re

turn

s of

the

S&P/

TSX

Com

posi

te In

dex

Source: Morningstar Encorr, As at December 31, 2009. Intended for illustrative purposes.

Perceived losses

What does this feel like?

Actual returns

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ASSET BACKED & MORTGAGE BACKED SECURITIES RISK

Investment risks to educate your clients about

CONCENTRATION RISK

CREDIT RISK

CURRENCY RISK

DERIVATIVE RISK

EQUITY RISK

FOREIGN INVESTMENT RISK

INTEREST RATE RISK


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Historically, markets go up more than they go down

Source: Standard and Poor's, Ibbotson, Robert Shiller, Fidelity Management and Research Company (Mare). March 31, 2010.

S&P500 CALENDAR YEAR STOCK RETURNS (1825 - 2009)

19331862190818431955183019611846191918291896182619131827189318251917183919371931

20001910

19351863195819041963185219211832190218361914183319031828193018571954187919751915196718801926183419061840192918351920183119741907

1985192719721885193818381911184219341845193218372002198919281976189119421847191218441940185119411841199519361980189819441848191618561946185319691854199719451983190119491849192318591957186019731876

19861918195218501939186519601861200118841991192219591855194718661962187319961924196418581948186719661877199819251965186419531869197718831999194319681872195618701981188720031950197118741970187119901890

1951197918781978187519821886198418811988189719871882199218991993188820041900199418892006190520051892

1909200718941895

2008

60%50%40%30%20%10%0%-10%-20%-30%-40%-50%

2009

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Help clients understand what they own

SHOPPERS DRUG MART

RESEARCH IN MOTION

ROYAL BANK

ROGERS

CANADIAN NATIONAL RAILWAY

GOOGLE

AT&T

MICROSOFT

PFIZER

WAL-MART

For illustrative purposes only. As at March 31, 2010.

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Provide clients with anchors

3 Registered Pension Plan

2 Canada Pension Plan/Quebec Pension Plan

1 A written financial plan


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Clients will only focus on what they see….

their advisor must see the entire picture!

How do the best protect their clients?

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rational investing in an emotional world june - cifps · read a fund’s prospectus before...

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