Luck vs. Skill: State Street’s Center for Applied Research Finds Investors’ Devotion to Alpha is Hindering Investment Suc...
November 17 2014 - 9:47AM
Business Wire
New Research Examines How Investors Perceive Luck, Skill and the
Pursuit of Alpha Relative to Long-Term Investment Goals
Investment professionals are failing to deliver alpha and
investors are failing to achieve their long-term goals, according
to new research published today by the Center for Applied Research,
the independent think-tank of State Street (NYSE: STT). The
research, titled “The Folklore of Finance: How Beliefs and
Behaviors Sabotage Success in the Investment Management Industry”
explores the concept of investment success and the impact of common
beliefs and biases within the investment management industry.
While more than 60 percent of the industry’s capital is spent on
the pursuit of alpha, a growing skepticism has emerged. Only 53
percent of individual investors and 42 percent of investment
professionals believe that alpha production is primarily driven by
skill. In addition, when questioned about whether they were
prepared to meet their investment goals, only 12 percent of
individual investors could say with confidence that they were.
“The models for success in the investment management industry
are broken,” said Kelly McKenna, global head of the Center for
Applied Research, State Street. “Investment professionals pay
significantly more attention to activities that they believe will
contribute value to alpha. While some of these are helpful, many
are of limited value. True success includes not only achieving
alpha, it also requires helping investors achieve their long-term
goals, sustainably, over time.”
Influencing this are the shared beliefs, rooted in human bias,
that govern both investment professionals’ and investors’
behaviors. The report investigates those beliefs, which can be
broken down into three major categories, two of which can be
described as conscious and one that is unconscious and hidden.
The Conscious “Folklore of Time and False Comfort”:
Individual investors and investment professionals are overly
reliant on past performance when making investment decisions
despite the fact that past performance is not an indication of
future results. They also consistently fail to focus on long-term
goals when evaluating short-term performance.
- Nearly 60% of investment professionals
use a timeframe of just one to three years to assess performance.
In addition, more than 60% of individual investors say they would
consider moving to a more conservative investment strategy if their
portfolio declined by 20% in a year, of those 90% would make the
change in less than three months.
- Only 22% of institutional investors
define success based on achieving long-term investment goals and
instead, the vast majority (63%) measure success against
benchmarks.
- Additionally, less than 30% of
individual investors define success as achieving their long- term
goals and instead cite implausible or irrelevant success metrics
like making gains and having no losses, outperforming the market
and achieving short-term investment goals.
The Unconscious “Folklore of Knowledge”:
The majority of portfolio managers surveyed exhibit an
unconscious ‘self-attribution’ bias. Without realizing it, they
credit themselves for their success, but blame external factors for
their failures. Similarly, individual investors demonstrate
significant overconfidence in their own abilities.
- Seventy-seven percent of asset managers
and 47% of intermediaries cited “experience and analytical process”
as the top reason they outperform, but when asked to explain
underperformance, were more likely to blame market conditions,
clients’ expectations or the senior management of companies they
invested in.
- Nearly two-thirds of individual
investors believe their current level of financial sophistication
is advanced; however, when asked to complete a financial literacy
test, the global financial literacy average score was just
61%.
- Despite this, 93% of individual
investors believe they should make investment decisions themselves
and two-thirds think their best investment was entirely their own
decision.
“While conscious and unconscious biases are one of the primary
reasons investment professionals and individual investors are
failing to achieve true success, an awareness of those biases is
part of the solution,” said Suzanne Duncan, global head of
research, Center for Applied Research, State Street. “It’s time to
rewrite the story. By reconditioning the industry’s behavior,
there’s an opportunity to reinforce the values necessary to achieve
true success.”
The Center for Applied Research obtained input for this study
through surveys of 3,744 investors, investment providers,
government officials and regulators across 19 countries. The
research was completed over a period of 18 months.
To view the report click here.
About State Street Corporation
State Street Corporation (NYSE: STT) is one of the world's
leading providers of financial services to institutional investors
including investment servicing, investment management and
investment research and trading. With $28.47 trillion in assets
under custody and administration and $2.42 trillion* in assets
under management as of September 30, 2014, State Street operates in
more than 100 geographic markets worldwide, including the US,
Canada, Europe, the Middle East and Asia. For more information,
visit State Street’s web site at www.statestreet.com.
* Assets under management include the assets of the SPDR® Gold
ETF (approximately $30 billion as of September 30, 2014), for which
State Street Global Markets, LLC, an affiliate of SSgA, serves as
the distribution agent.
CORP-1171
State Street CorporationAnne McNally,
+1-617-664-8576aemcnally@statestreet.com@StateStreet
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