CFA Caymans May 2016

8/16/2019 CFA Caymans May 2016

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Crashes, Terrorists, Sharks - Oh, My!

Why investors fear the wrong things,

and what you can do about it…

CFA Society Cayman Islands

May 2016

Barry Ritholtz


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This evening’s discussion:

I. What do we fear – & why?

II. How do our fears impact our

performance – as analysts & investors?

III. Can we manage these issues? (Yes)


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Part I: What do we fear – & why?


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You Are Going to Die . . . Here’s How.

Shark : A perfectly evolved killing machine, immortalized in Spielberg’s 1975 film, “Jaws.”


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Source: Ritholtz.com

Death by Selfie

1 Fell off a cliff in S. Africa.

2. Live hand grenade (2).3. Oncoming train (3).

4. Electrocutedby high-voltage wire (1).

by live wires (1)6. Shot in head with a gun.7. Fell from bridge.

8. Fatally shot himself9. Fell down Taj Mahal steps


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6-10 people per year are

killed by sharks worldwide

Other large predators:

Lions (100)

Elephants (100)Hippos (500)

Crocodiles (1,000)

Dogs (25,000)

Snakes (50,000)


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Source: Gates Foundation, CDC

The Deadliest Animal in the World

Mosquitoes are the deadliest creature on earth;

(Human are only second)


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Source: LA Times

What killed Americans in 1900 vs. 2010


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Risk of Terrorism

Source: CDC, Mueller & Stewart, Terror, Security, and Money.

2010: U.S.

noncombatant

fatalities from

terrorism

worldwide = 25

2011: Terror

deaths = 8

Annual deaths

due to struck

by lightning =

29 .


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Your Actual Risk

You are …

35,079 times more likely to die of heart disease

33,842 times more likely to die of cancer

… than a terror attack.Source: CDC


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Fear of Flying ?

Max Planck Institute (Berlin)

Fear leads to

emotional

decisions

which leadto poor

outcomes


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What are we afraid of in Markets?


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Crash! Hyperinflation! Dollar Collapse!

Market Crashes

HyperInflation

Collapse of the

Dollar

Looking foolish…


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S&P500 Declines of 20% (or more)


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Faber on Hyperinflation: “Not A Matter Of If But When” –Business Insider, 9/23/2010

'The Bear Market Is Starting' Marc Faber –CNBC, August 3, 2011

Faber: “The Dollar's Value In The Future Will Be Zero” –Business Insider, 4/18/ 2011

Marc Faber: “We Could Experience A 1987-Style Crash This Year” –Business Insider,

5/10/2012

Marc Faber: “Look out! A 1987-style crash is coming.” –CNBC, August 8, 2013

“2014 crash will be worse than 1987's” Marc Faber –CNBC, April 10, 2014

“Dr. Doom calls bubble, adding to gloomy calls” –CNBC, Nov 2, 2015

“Asset Markets Will Crash Like Titanic” -Bloomberg, January 6, 2016

Catastrophizing Markets


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Global Central Banks Are Running ‘Out of Ammo’

(CNN/Money February 9, 2016)

Rate-Hikers At the Fed Are Running Out of Ammo

(CNBC May 13, 2015)

Fed Has No Ammo Left (USA Today March 2014)

Federal Reserve: What Happens When The Fed Really

Does Run Out of Ammo? (Time February 27, 2013)

Fed Running Out of Ammo (Politico July 31, 2012)

Fed Out of Ammo For Economy (WaPo 8/26/ 2011)

Fed Running Low on Ammo (WSJ August 26, 2010)

Fed Running Low on Ammo (Reuters August 18, 2009)

Catastrophizing Central Bankers

Economist, Feb 20th 2016


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Part II: How do your fears impact performance?


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1. Herding, Groupthink

2. Optimism Bias

3. Confirmation Bias

4. Expert Opinions

5. Recency Effect

6. Endowment Effect

7. Hindsight Bias

8. Risk Aversion

Behavioral Economics Neuro-Finance

How Your Brain Interferes with Your Investing

Risk Aversion

1. Anticipation vs. Rewards

2. Selective Perception/Retention

3. Words vs Images

4. Pattern Recognition

5. Data vs Narrative

6. Cognitive Dissonance

7. Species of Dopamine Addicts

1. Misunderstanding risk

2. The purpose of fear

3. Black Swans

4. Evolutionary baggage

5. Biggest Financial Fears

6. Overcompensation

7. What hurts performance


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Off Label Use

antihistamine diphenhydramine. sildeenafil


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Your Brain is being used “Off Label”


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Risk Aversion: Pleasure versus Pain


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Source: DALBAR

Investor Performance (10 Years)


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Investor Performance (20 Years)


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Source: Ritholtz.com

Sentiment Cycle


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Source: Ritholtz.com BigCharts.com

These are poorly designed tax cuts - Stay Out of Markets!

2003: Politics and Asset Management Don’t Mix


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Source: Ritholtz.com, BigCharts.com

2003 Tax Cuts > $1 Trillion

Up over 90% over 4 years



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Obama is a Socialist! Stay Out of Markets!

2009: Political Investing


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FASB 157, ZIRP, QE +VERY Oversold Markets

Up 207% over 75 months



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Part III: How can we manage these issues?


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Defining Investment Risk

“The probability that actual

returns on an investment will be

lower than the expected returns.”


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Fear of Deadly Viruses


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Risk . . .

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=02!4A0?D E< F52/G958 HI::G


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Reward !

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!"#$%& #( )*++


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35

MSCI World Index,1970–2013

$43

US homepriceshitbottom

Fiscalcliffworries

Euro zonedebtcrisis

S&P 500down 46%

Subprimemortgagecrisis

HurricanesKatrinaand Rita

Iraqwarbegins

Dotcomstockcrash

9/11terroristattack

Y2KScar

e

Russianfinancial

crisis

Asiancurrency

crisis

Income taxratesrate

IraqinvadesKuwait

Savingsand loancrisis

Dow drops23% on BlackMonday

USinflationat13.5%

BusinessWeek:“The Death ofEquities”

Gold hits

record high

S&P 500down43%

Oil pricesquadruple

Arab oilembargo

1970 1980 1990 2000 2010 2013

1

A disciplined investor looks beyond the

concerns of today to the long-term growth

potential of markets.

US homeprices hitbottom

Fiscalcliffworries

Eurozonedebt crisis

S&P 500down 46%

Subprimemortgagecrisis

HurricanesKatrinaand Rita

Iraq warbegins

Dotcomstockcrash

9/11terroristattacks

Y2KScare

Russianfinancial

crisis

Asiancurrency

crisis

Income taxrates rise

IraqinvadesKuwait

Savings and

loan crisis

Dow drops 23% onBlack Monday

US inflationat 13.5%

BusinessWeek:“The Deathof Equities”

Gold hits

record high

S&P 500down 43%

Oil pricesquadruple

Arab oilembargo

1970 1980 1990 2000 2010 2013

In US dollars. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is noguarantee of future results. MSCI data © MSCI 2014, all rights reserved.

Markets Have Rewarded Discipline


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-9%

12%

28%

41%

82% 85%92%

110%

121%

154%

176%

-50%

0%

50%

100%

150%

200% "The Lost Decade" Total Returns January 2000 - December 2009

36

You Don’t Have to Pick Just One


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37

Portfolio Yield: 2.77%

Annual Expense Ratio: 0.29%Asset Class AllocationInternational Stocks 24%

U.S. Large Cap Stocks 18%

U.S. Investment Grade Bonds 14%

Emerging Market Stocks 9%

U.S. Mid Cap Stocks 8%

U.S. Small Cap Stocks 7%

Mortgage Backed Bonds 6%

Inflation Protected Treasury Bonds 5%

Real Estate Investment Trusts 4%

U.S. High-Yield Bonds 4%

Cash 1%

The Diversified Portfolio


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The Endowment Model

Asset Allocation

Opaque: Illiquid Securities,

Leverage & Little Transparency

Transparent: Liquid Holdings,

Daily Pricing & Complete

Transparency

Operationally Challenging with

Higher Fees

Operationally E"cient with

Lower Fees

Risk measurement through

complex quantitative risk

models

Risk management through

intelligent asset allocation &

diversification

Try to avoid volatility

Use volatility to your advantage

and survive periods of severe

disruptions

Complex vs. Simple


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1. Lack of Discipline2. Excess Trading

3. Lack of Diversification

4. Unnecessary Trading Costs/Fees

5. High Turnover = High Taxes6. Over Confidence

7. Deviating from Strategy (“style drift”)

8. Marrying Forecasts / Predictions

9. Relying on Pundits10. Emotional Decision-making

Why Investors Underperform


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What You Can Control


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Understand Risk:

a) Recognize its importance to

achieving returns; b) Embrace appropriate levels;

c) Beware risk aversion.

Avoid the usual mistakes!

The War Between You & Your Brain


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“We have met the

enemy, and he is us.”

-Walt Kelly, Pogo, 1971


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Barry L. Ritholtz

Chairman,

Chief Investment Officer,

Ritholtz Wealth Management

90 Park Avenue, 18th floor

New York, NY 10016

212-455-9122

[email protected]

for more information, please contact

My favorite books on these subjects can be found at

http://www.ritholtz.com/behavioral-books


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CFA Caymans May 2016

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