ArticlePDF Available
8 www.cfapubs.org ©2010 CFA Institute
guest editorial
Meir Statman
Glenn Klimek Professor of Finance
Santa Clara University, Santa Clara, California
Visiting Professor of Finance
Tilburg University, the Netherlands
Editors Note: With this piece, the FA J introduces the Guest Editorial column, which will appear occasionally.
What Investors Really Want
We want more from our investments than a reason-
able balance between risk and return. We want to
nurture hope for riches and banish fear of poverty.
We want to win, be number one, and beat the mar-
ket. We want to feel pride when our investments
bring gains and avoid regret when they inflict
losses. We want the status conveyed by hedge
funds, the virtue conveyed by socially responsible
funds, the patriotism conveyed by investing in our
own country, and the loyalty conveyed by investing
in the companies that employ us. We want financial
markets to be fair, but we search for an edge that
would let us win. We want to leave a legacy for our
children when we are gone. And we want to leave
nothing for the tax man.
Standard finance proclaims that investors are
rational, free of cognitive errors. Much of behav-
ioral finance says that investors are irrational, beset
by a host of cognitive errors. Lost in the middle are
normal investors like you and me. We are intelli-
gent people, neither rational nor insane. We are
“normal smart” at some times and “normal stupid”
at others. But we must distinguish investment
wants from cognitive errors and empathize with
fellow investors who do not share our wants.
Some of us are willing to pay money for the
game of golf, including the cost of clubs, balls, and
fees. Golf seems stupid to me—a cognitive error
that misleads avid players into spoiling a good
walk. But I empathize with golf’s passionate play-
ers even if I don’t share their passion. Some of us
are passionate players of the investment game,
willing to pay commissions for trades, subscrip-
tions for newsletters that promise to foresee the
market, and fees for mutual funds that promise to
beat it. I empathize with their passion as well, even
if I don’t share it.
Investments offer three kinds of benefits: util-
itarian, expressive, and emotional. Utilitarian
benefits are the answer to the question, What does
it do for me and my pocketbook? The utilitarian
benefits of watches include time telling, the utilitar-
ian benefits of restaurants include nutritious calo-
ries, and the utilitarian benefits of investments are
mostly high returns with commensurate risk.
Expressive benefits convey to us and to others
our values, tastes, and status. They are the answer
to the question, What does it say about me to others
and to me? A stock picker says, “I am a winner, able
to pick winning stocks.” Emotional benefits are the
answer to the question, How does it make me feel?
The best tables at prestigious restaurants make us
feel proud, private equity makes us feel important,
lottery tickets and speculative stocks give us hope,
and stock trading is exciting.
We are not embarrassed to admit that we want
our investments to support us during our retire-
ment years. Nor are we embarrassed to admit that
we want our investments to support our children
or favorite charities. But some of what we want
from our investments is embarrassing. We might
want to mention our investments in hedge funds,
knowing that hedge funds signal high status
because they are available only to the rich. But a
loud expression of status, like a display of an over-
sized logo on a Gucci bag, can bring embarrassment
rather than an acknowledgment of status.
Wants are also difficult to acknowledge
because they often conflict with “shoulds.” The
voice of wants says, “I want this new, red sports
car,” but the voice of shoulds says, “You should
buy a used sedan and add the difference in price to
your retirement account.” Investment advice is full
of shoulds—save more, spend less, diversify, buy
and hold. Wants are visceral, whereas shoulds are
reasoned. Wants emphasize the expressive and
emotional benefits of investments, whereas
shoulds emphasize the utilitarian benefits.
Marketing professionals are not puzzled by the
commingling of utilitarian, expressive, and emo-
tional benefits. Indeed, such commingling is at the
center of their work. Marketing professionals know
that watchmakers can sell $10 watches for $10,000
by commingling the watches’ time-telling utilitarian
[ADVERTISEMENT]
10 www.cfapubs.org ©2010 CFA Institute
Financial Analysts Journal
benefits with the expressive and emotional benefits
of status. But investment professionals and profes-
sors of finance prefer to keep their distance from
marketing, in words if not in actions. They are often
perplexed by the commingling and are uncomfort-
able with it. Yet investment professionals and pro-
fessors of finance cannot hope to understand the
world of investments without understanding this
commingling, and investment professionals cannot
serve their clients well without that understanding.
Financial advisers are often puzzled by the
desire of some investors to exclude the stocks of
tobacco companies from their portfolios. Why not
invest in tobacco stocks if they produce the highest
returns and then use those returns for antismoking
campaigns? This suggestion makes as much sense
to socially responsible investors as a suggestion to
Orthodox Jews that they forgo kosher beef for
cheaper and perhaps tastier pork and donate the
savings to their synagogues. Money managers
often assert that they compete with other money
managers by generating the highest alphas and
denigrate the role of marketing in the competition.
Yet every money manager has stories about other
money managers with low alphas who snatched
clients through clever marketing.
Money managers, financial advisers, security
designers, and all other investment professionals
practice marketing when they seek to under-
stand investor needs—utilitarian, expressive, and
emotional—and satisfy them. Yet investment profes-
sionals are reluctant to discuss marketing, and few
articles link marketing to the investment profession.
The time has come to make the link between invest-
ment and marketing stronger and more explicit.
Although researchers are still looking for mod-
els of expected returns that recognize the role of
utilitarian risk, they seem uninterested in finding
models that recognize the roles of expressive and
emotional characteristics. We have moved from the
capital asset pricing model, in which beta measures
risk, to the three-factor model, in which size and
book to market measure risk. But size and book to
market probably measure affect, an expressive and
emotional characteristic, more than they measure
risk. The stocks of Google, Apple, and other growth
companies have positive affect, which attracts
investors, whereas the stocks of Citigroup, Bank of
America, and other value companies have negative
affect, which repels investors. We need to include
in models of expected returns such expressive and
emotional characteristics as affect, social responsi-
bility, status, and patriotism.
BE A PART
OF
HISTORY
50 YEARS
CFA Institute is collecting CFA exam stories from its
members for possible inclusion in an upcoming book
on the first 50 years of the CFA Program. Have you
ever had something interesting or unusual happen
during one of your tests or during grading? If so,
please e-mail wendi.ruschmann@cfainstitute.org
or send your story to:
Wendi Ruschmann
CFA Institute Historian
P.O. Box 3668
Charlottesville, VA 22903-3668 USA
... Historically, institutional investor decision-making is driven by the objective of maximising riskadjusted financial return for their clients (Graham, Zweig & Buffett, 2003;Bodie, Kane & Marcus, 2008). Given the systemic and rapid impact of the global financial crisis of 2008 (Davis, 2009(Davis, , 2012Richardson, 2013;BBC News, 2014) and other financial sector scandals (Bogle 2005b;Davis 2012;The Economist, 2012), the process of how and why investment decisions are made beyond an exclusive interest in financial return has garnered ongoing academic and industry attention (Hilton, 2001;Guyatt, 2005Guyatt, , 2006Hill, Ainscough, Shank, & Manullang, 2007;Williams, 2007;Glac, 2008;Richardson & Cragg, 2010;Barreda-Tarrazona, Matallín-Sáez & Balaguer-Franch 2011;Holland, 2011;Statman, 2011;Richardson, 2013;Viviers, 2013;Sievänen, 2014;Kay, 2015;Jenkinson, Jones & Martinez, 2016;Haldane, 2016;Amel-Zadeh & Serafeim, 2018) . In parallel to events leading up to the global financial crisis and the ramifications since, there has been an emergence of normative frameworks and global initiatives that are intended to encourage more sustainable and responsible investment practices (Fowler & Hope, 2007;Gifford, 2010;Richardson, 2011;Viviers & Eccles, 2012;Viviers, 2014a;Malan, 2015;Grushina, 2017). ...
... A growing body of research suggests that the inclusion of these risks into investment decision-making positively impacts financial return, especially in the medium to long term, supporting the business case for ESG integration (Holland, 2011;Eccles et al., 2012;Van der Ahee, 2012;Gifford, 2013;Clark et al., 2014;Amel-Zadeh & Serafeim, 2018;Serafeim, 2018). Statman (2011) adds to this argument by proposing that investors are not merely seeking utilitarian outcomes for the investment, but emotional and expressive purposes as well. Completing the circle, investment decisions are not only a function of outcomes for the investor alone, but also impact on the investee company and the system of stakeholders associated with that investment decision. ...
Thesis
Full-text available
Institutional investors, as agents of other people’s money, have come to dominate investment holdings globally. Through the concentration of ownership of the assets they are mandated to manage, institutional investors have the right and power to influence decision-making in the companies in which they invest. Consequently, the decisions they make regarding investments can significantly impact the stakeholders and economies connected to these assets. Traditionally, institutional investor decision-making has been driven by the objective of maximising risk-adjusted financial return without commensurate attention given to the environmental and social impact of the investments made. The legacy of South Africa’s colonial history, coupled with the global repercussions of financial sector failures and company collapses, has generated ongoing debate and academic enquiry into the roles and responsibilities of institutional investors and their investment decision-making process. In response to the acknowledgement for greater accountability and action, more ‘responsible’ investment principles, policies and practices that consider environmental, social and governance (ESG) criteria in investment decision-making have emerged. Responsible Investing (RI) has risen to prominence since the launch of the United Nations Principles of Responsible Investment in 2006. In South Africa, since 2006, increased awareness of and participation in RI has been spurred on by changes in legislation and the development and adoption of codes of corporate governance by civil society and increasingly by the private and public sectors. Despite progress in policy and practice, research has found that barriers to the growth of RI in South Africa outweigh the drivers and enablers. In addition, there appears to be lack of commitment among South African institutional investors, with them being characterised as having a ‘passive and selective approach’ to RI. With the aim of better understanding the connection between institutional investors and the impact of their investment decisions, this study sought to identify and analyse the factors influencing the decisions, decision makers and decision-making processes of South African institutional investors towards RI. Theoretical and sector research over the period 2013 to 2018 highlighted the characteristics of the stakeholders in the institutional investment value chain in South Africa from a stakeholder perspective and the factors influencing their respective decision-making processes. Senior decision-makers from a broad representation of identified institutional investor categories were the units of analysis. Influenced by transdisciplinary and participatory action research methods, over 30 semi-structured interviews were undertaken to gather primary data for the study that were recorded, transcribed, coded and analysed. Through ongoing consultation with academic and investment professionals, the analysis of relevant theory, industry reports and empirical data, the researcher formulated and refined a conceptual framework that proposes an integrated view of the factors influencing the investment decision-making towards RI. The framework consists of stakeholders in commercial and contractual value chains influenced by social, political, ethical and legal structures, informed by a variety of information sources and metrics reported over time and ESG horizons. The conceptual framework illustrates the aspects and connections between institutional investors and the stakeholders impacted through their investment decisions. The empirical evidence points to the adoption of a more holistic, specific, stakeholder-driven view of the investment value chain to improve RI policy and practice, recommending mutual accountability to optimise stakeholder salience, improve accountability, guide engagement and promote participation in the investment decision-making process. The study contributes to the body of knowledge from descriptive, instrumental and normative perspectives aligned to stakeholder theory as well as advancements to institutional investing and responsible investing research, particularly in South Africa. The study provides a detailed conceptual framework consisting of a taxonomy of institutional investors and an integrated view of the cross-sectoral factors and detailed explanations of the phenomena observed or deduced from empirical research and relevant literature that connect institutional investors’ decision-making to the stakeholders impacted by the decisions they make. The conceptual framework offers model to assist investment decision-making and thus an instrumental tool to inspire praxis in decision-makers, especially asset owners, individual contributors and their beneficiaries, enabling deeper understanding of the factors to consider in their investment decision-making process. Against the background of stakeholder theory, the study offers stakeholder-specific recommendations to address the inertia and inconsistency in the entrenchment of RI philosophy, policy and practice prevalent among institutional investors in South Africa. Furthermore, the interpretation of the unique characteristics that South Africa presents through the lens of its political economy and the theory of the state, informed recommendations towards a more ‘collibratory’ approach to improving the adoption of RI.
Article
Full-text available
We investigate the existence of evidence of investor sentiment on share price deviations from their intrinsic values across two sentiment regimes of shares market: the low-to-normal and the excess one. We use the residual income valuation model to calculate the intrinsic values of shares based on accounting fundamentals and we suggest a panel data threshold model to capture the sentiment regimes of the market, using as threshold variable alternative investor sentiment indices. The suggested model enables us, first, to endogenously identify from the data the threshold value of a sentiment index triggering market sentiment regime shifts and, based on it, to examine if the effects of investor sentiment on share prices across the above two sentiment regimes are in accordance to the theory. Application of the model to UK data shows that investor sentiment influences positively share prices in the low-to-normal and negatively in the excess one. We also show that investor sentiment dominates risk premium effects on shares characterized by low book-to-market, and dividend- and earnings-to-price ratios. The above results are consistent with the predictions of the sentiment hypothesis.
Preprint
Full-text available
Behavioural finance points out various investor biases and heuristics which inhibit optimal investment choices and are sometimes deemed irrational. Although emotions are often viewed as anathema to sound financial decisions, there is a big emotional component that has to be taken into consideration when holistically defining financial goals. Investors have differing goals for investing. Portfolio theory should therefore not overlook these goals and its horizon should be expanded to offer investors with the best possible achievable solutions by incorporating financially efficient anxiety reduction. A rational solution should therefore take investors' behavioural shortcoming into account because investors do not simply care about risk-adjusted returns but the best returns that can be achieved for the level of stress they are going to have to endure over the volatile investment journey.
Article
We consider asset prices and informational efficiency in a setting where owning stock confers direct utility due to an affect heuristic. Specifically, holding equity in brand name companies or those indulging in “socially desirable” activities (e.g., environmental consciousness) confers positive consumption benefits, whereas investing in “sin stocks” yields the reverse. In contrast to settings based on wealth considerations alone, expected stock prices deviate from expected fundamentals even when assets are in zero net supply. Stocks that yield high direct utility are, on average, more informationally efficient as they stimulate more entry into the market for these stocks and, consequently, more information collection. The analysis also accords with a value effect, high valuations of brand‐name stocks, abnormally positive returns on “sin stocks,” volume premia in the cross‐section of returns, proliferation of mutual funds and ETFs, and yields untested implications. If, as psychological literature suggests, agents derive greater utility from successful companies by “basking in reflected glory,” then asset prices react to public signals non‐linearly, leading to booms and busts, as well as crashes and recoveries.
Chapter
Prior studies, which analyse the performance of socially responsible investments (SRIs) compared to conventional funds, have thus far ignored the assessment of risk. In response to this identified lack of research, we make a major attempt to fill the void by investigating whether daily returns of Australian equity socially responsible investment funds have different tail risk exposure in the return distribution compared to matched conventional equity funds. The Australian funds management industry provides a natural setting within which to study the risk exposure of SRI funds. The Australian funds management industry has one of the largest and fastest growing funds management sectors in the world. This growth is underpinned by Australia’s government-mandated retirement scheme. In addition, Australia is the first country to introduce regulations that require issuers of financial products and financial advisors to disclose and advise on ethical, social, and governance (ESG) considerations. Using a sample of 26 funds spanning the period 1998–2013, we establish several new findings. First, in assessing tail risk exposure we observe no evidence of significant difference in riskiness amongst socially responsible investment compared to that of conventional funds with similar investment styles. Second, when comparing two downside risk measures across socially responsible and matched conventional funds, namely Value-at-Risk and expected shortfall, we find that return distributions amongst Australian funds do not exhibit particularly heavy tails. Taken together, we show that investors do not pay a penalty (in terms of higher risk) to invest ethically.
Chapter
This chapter reviews the concept of mental accounting and describes Brinker Capital's approach to helping investors reach their important personal goals by allocating funds to four buckets (Safety, Income, Tactical, Accumulation) that align both with Maslow's hierarchy of needs and Behavioral Portfolio Theory. Intentionally framing one's investments in this way helps increase the vividness of their goals, provide greater opportunities for having a sense of achievement in investing, and inspire action today. Mental accounting is in the strictest sense, irrational behavior. Since mental accounting is an irrational behavior, much of the historical focus on mental accounting has been on the ways in which it thwarts good financial behavior. The process of mental accounting is itself a form of simplification. The chapter discusses in detail how mental accounting and framing can increase salience, improve one's ability to take a longer-term view, and derive more pleasure from working toward multiple, smaller goals. It also presents a case study related to goals-based mental accounts.
Chapter
Based on a Morningstar poll (912 responses; poll taken November 10, 2009), “More Advisors Are Reporting that 76–100% of their Client Groups are Using Alternative Investments than Last Year,”1 both finance experts and investors clearly see the merits of diversifying with alternative investments. In Smart Money’s “Own More ‘Alternatives,’” “The financial crisis did more than just shred the mystique of the buy-and-hold era; it also left many investors skeptical of the idea that stocks, bonds and cash were enough to see them through to the finish line. After all, stocks and bonds both took huge tumbles simultaneously, and low interest rates during the recovery made most people’s cash holdings about as profitable as a pet rock. Those trends are fueling demand for a wider array of assets—from long-short funds, which can improve their returns by betting against stocks, to commodities, which tend to rise when stocks fall.”2
Article
Purpose The purpose of this paper is to determine if there is a significant difference in the investment risks between small-cap manufacturers that heavily depend on one or a few buyers, referred to as “dependent-buyers,” and small-cap manufacturers that have a more diversified customer base. If there is a significant difference both statistically and economically, then investors need to be aware of the dependent-buyer effect in their security selection and portfolio construction efforts. Design/methodology/approach Using large samples of firm-level data from 2000 through 2011, the authors employ standard risk estimation modeling to compute βs, idiosyncratic risks, and total risks of both dependent-buyer firms and firms with a more diversified customer base. Findings The authors find that the βs, idiosyncratic risks, and total risks of dependent-buyer firms are much greater than that of firms not in dependent relationships. These differences are both statistically and economically significant. Research limitations/implications Buyer-supplier relationships can change quickly, and so a firm that has a diversified base in one period, for example, could be a dependent-buyer in the next period. Much depends on the reporting accuracy of firms and the ability of the securities exchange commission (SEC) to track the relationships. Practical implications First, the risk of individual small-cap stocks is likely to be greater than perceived from macro-level data, leading to the need for more securities if idiosyncratic risk is to be eliminated. Second, small-cap investors have the opportunity to enhance portfolio construction efficiency by referencing data published by the SEC. Third, most investors interested in small-cap manufacturing stocks should find it prudent to allocate a large percentage of their small-cap investments to an index fund. While this may sacrifice higher returns, it also reduces the probability of experiencing an unpleasant small-stock effect. Originality/value This is the first study to show that the difference in investment risks between small-cap manufacturers that depend on one or a few firms for their outputs and small-cap manufacturers that have a well-diversified customer base is statistically and economically significant, information that should be valuable to investors in their security selection and portfolio construction efforts.
ResearchGate has not been able to resolve any references for this publication.