The start of a new year inevitably brings a period of reflection and our thoughts turned to 2007. The year was memorable for a number of reasons; in the world of science and technology it saw Steve Jobs of Apple announce the launch of the iPhone and Amazon release the first version of the Kindle; in politics, Nicholas Sarkozy became President of France and Gordon Brown replaced Tony Blair as Prime Minister of the UK. It was the year JK Rowling finished her seventh and final Harry Potter novel; the Scout Movement celebrated its centenary and the year Mauritania criminalized slavery, making the practice illegal everywhere in the world for the first time in history.
As noteworthy as these events were, for those of us working in financial services, the year 2007 is particularly significant as it marked the start of what became later defined as the Global Financial Crisis (GFC). To be precise, on 9 August 2007 the pending seizure of the global banking system was precipitated by BNP Paribas’s announcement it was ceasing activity in three hedge funds specialising in US mortgage debt. This was the moment it started to become clear such assets, which sat on institutional balance sheets around the world, were worth considerably less than many – the regulators included - had previously imagined. As we know, trust and confidence quickly evaporated, and many banks ceased doing business with each other.
The rest, as they say, is history. However, the repercussions and scars of those events live on to this day; not only in terms of the global economy and the huge debt burden created, but in the hearts and minds of investors. We have regularly made reference to behavioural psychology and the impact it has on financial markets. There is no doubt the trauma caused by the first ‘bank run’ in Britain in 150 years (Northern Rock), or the collapse of Lehman Brothers in the US, continues to influence how investors allocate their capital.
Crowds queue to withdraw savings – 15 September 2007
Not only is this time of year a catalyst for reflection, it is also – habitually - a time when many of us think about eating healthily and exercising more frequently. How many of us, though, apply this mind set to our brains; in other words, consider our ‘brain’s health’ as well as our ‘body’s health’?
Decision making and decision fatigue
As professional investors, we spend a lot of time thinking about markets and the process we use to access them. This involves making decisions and the organ controlling this is, of course, the brain. It has been estimated the average adult makes close to 35,000 decisions during a typical day. Furthermore, researchers have proved each of us has a finite store of ‘decision-making’ energy for that day and once this becomes depleted, we are simply unable to make decisions or, more commonly, make irrational or poorly thought through decisions.
Delving deeper into the science, it is understood once we become mentally depleted, we become reluctant to make trade-offs – risk/reward or cost/benefit analyses – which involves a particularly advanced and taxing form of decision making. To ‘compromise’ is a complex human ability and one of the first to decline when we are brain-tired. To manage the ongoing decisions being faced – remember, we may have ‘only’ made 30,000 and have another 5,000 to make – researchers describe humans as entering a state where we become ‘cognitive misers’ and hoard our mental energy. As an example, if out shopping, we would be liable to look at things in one dimension, like price: ‘just give me the cheapest’. Or, we would indulge ourselves by just looking at quality: ‘I want the best’.
This ‘decision fatigue’ leaves us vulnerable to exploitation by marketers and many of you will, no doubt, be able to cite when you have fallen victim to this. A classic example is the process faced by new car buyers. Once you have selected the model you want to buy, there are a myriad of other decisions you are asked to make. For instance, you may have to choose between 4 styles of gear shift knobs, 13 kinds of wheel rims, 25 configurations of engine and gearbox and 56 combinations of interior. Typically, at the start of the selection process, buyers carefully weigh each of their choices but, as decision fatigue sets in, they settle for default options or one dimensional logic, such as ‘how does it look?’. Car manufacturers can manipulate the order of the choices, optimising their highest margin features for when we are suffering most from decision fatigue.
How to manage decision fatigue – ensuring good brain health
Making decisions is hard work and managing assets through 2017 will require crucial decisions be made as we seek to answer important questions. How will President Trump impact US economic growth, Fed policy and the dollar?; to what extent will the UK slow as Article 50 is invoked?; will geopolitics trigger increased uncertainty across the Eurozone?; can EM assets perform in the face of dollar strength? What tactics can we employ to help alleviate decision fatigue, when debating these and the many other questions faced?
Given the increased awareness of the hazards associated with a tired brain, important decision-makers have learned to employ a variety of methods to alleviate the dangers. For example, when discussing this topic, President Obama highlighted he only ever wears a grey or blue suit, stating; ‘you need to remove from your life the day-to-day problems that absorb most people for meaningful parts of their day. I am trying to pare down decisions and do not want to decide what I’m eating or wearing; I have too many other decisions to make’. For the same reason, Steve Jobs wore the same outfit every day at Apple.
Other methods may seem obvious, but many of us are guilty of taking our brain health for granted and neglecting to look after it. The brain needs glucose to function so, ideally, we should eat little and often. Plenty of sleep also aids better decision-making; checking emails, just before bed, runs counter to this. We need to plan for potential brain fatigue, for example, avoiding arranging important meetings late in the day. Taking time out is also key; be it exercise, reading a book, meditation or utilising our full holiday entitlement. None of this is rocket science, yet in today’s busy world, too often we fall into bad habits and fail to look after mind, as well as body.
Implications for portfolios
In the 10 years since the start of the GFC, we believe society as a whole – and the investment management industry, in particular – overvalue two things that have become abundantly available; data and choices. Add to this mix, a broad range of market participants carrying the emotional burden it created and we have a very complex environment in which we are active decision makers.
The ongoing pursuit to improve our investment process and our deeper understanding of decision fatigue is leading us to implement changes to our routines. More importantly, however, we believe it helps in interpreting the price action seen in risk assets through the second half of 2016. Trauma and uncertainty create angst - but with the UK’s vote to leave the EU and the election of Donald Trump moving these events from ‘known unknowns’ to ‘known knowns’, it seems apparent to us we are experiencing a wave of ‘anxiety release’. This is a powerful force and not one that is easy to bet against, nor predict how long it will last. This said we believe uncertainty will, once again, become a dominant state of mind as investors refocus on fundamentals. Fiscal stimulus and tax reforms will not transform an economy overnight, particularly when interest rates are rising, unit labour costs are higher and profit margins are being eroded. Nor can consumer confidence build when holidays, utility bills and weekly trips to the shops are increasingly expensive. We are therefore cautious about the medium-term outlook, with portfolios positioned accordingly.
Julia Warrander and Russell Waite
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