Behavioural finance has taught us a lot about the sub-optimal fashion in which investors (professional and private alike) arrive at decisions. It is 35 years since Kahneman and Tversky first outlined their version of what was to become prospect theory, highlighting the high value which investors accord to loss aversion relative to commensurate gains. Since then the field of behavioural analysis has expanded massively, most excitingly in recent years by aligning itself to the findings of neuroscience, which can track how different parts of the brain react to different intellectual and emotional challenges.
This is the full write-up of my recent interview with Terry Smith, the founder of Fundsmith. A shorter version appeared in the November 1st issue
I have no inside knowledge on whether Janet Yellen or Larry Summers is most likely to be given the job as the next chairman the Federal Reserve. It is not an exaggeration however to suggest, however, as many commentators have already noted, that this is probably the most important appointment that Mr Obama is likely to make in the course of his second term. If the media reports are to be believed, the White House is pushing the claims of the imperious Mr Summers over those of Mr Bernanke’s deputy, even though the former will face the tougher ride at Senate confirmation hearings.
Mr Bernanke’s pronouncement about the possible tapering of QE – call it a promise, call it a threat, according to taste – sent global financial markets in June into a spin. That is emblematic of the bizarre ways in which financial markets sometimes behave, for if tapering were indeed to begin in September or soon after, it would be a mostly positive development for anyone who still retains the capacity to think things through for the longer term. It would be ironic if fear of a negative market reaction was to jeapordise that outcome.
There is no bigger issue in the fund management circles that I frequent than the question of whether it still makes sense to hold the big global franchise stocks that have served investors so well over the past few years. In a world of artificially low interest rates, driven by the hair-raisingly experimental unconventional monetary policies now being pursued by the world’s main central banks, global businesses with strong free cash flow, balance sheets, an established competitive advantage and a consistent dividend track record have become the darlings of all fugitives from the return-free QE-squashed world of government bonds.
The primary job of any professional investor in bonds used to be to worry about what might go wrong, just as it was for equity investors to hope that things might go well. Today, you would think, there is even more reason for bond investors to worry when a vast swathe of fixed interest investments are priced to deliver negative real returns, now and into the future. One of the many strange features of today’s markets is that bond investors nevertheless seem to have transmuted into the market’s optimists.