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The psychological pull of separately managed accounts

July 2016

By NAB Asset Management

Separately Managed Accounts (SMAs) have been growing in popularity because of the tax advantages associated with holding securities directly, their transparency and the ability to access professional investment managers at a reasonable cost1.

But what about the psychological benefits SMAs could provide investors? I believe SMAs can help overcome some typical psychological barriers that people experience when they make investment decisions, including feelings of regret experienced when making spontaneous financial decisions and the need for control.

Feelings of control

Research has shown that nine out of ten investors make most of their financial decisions within a loss aversion framework. Loss aversion is the tendency for people to strongly prefer avoiding financial losses than acquiring financial gains.

While the degree of this aversion will be different for each individual, research has shown that losses have two and half times more emotional power than a similar valued financial gain2. Loss aversion is primarily an expression of fear. Investors try to fight this fear of loss by seeking control.

Unfortunately, this is where investors can make poor decisions. They often rely on recent news and outcomes to make decisions about random and unpredictable future events.

For example, in a well cited research experiment known as the ‘illusion of control’3, people were asked to predict the outcome of a coin toss. People who correctly predicted the coin tosses eight out of ten times felt they were significantly better than average at calling heads or tails. Given the opportunity, they believed they could get well over half their guesses right if the coin were tossed another 100 times. In contrast, people who incorrectly guessed the outcome early on or went through a period of inconsistency (having no prolonged streak), felt they had no ‘special gift’ for calling heads or tails. Of course we know this is a game of luck with no skill attached.  

SMAs can potentially provide investors with the ‘illusion of control’. That’s because investors feel they are in control of their assets, as ownership resides directly with them. But by outsourcing the management of securities to a professional fund manager, they insulate themselves from their own behavioural tendencies such as those driven by fear.

Overcoming feelings of regret

Neuroeconomic studies have shown that after some time, many investors begin to regret making any financial decisions – irrespective of the outcome4.

Some investors never forgive themselves for opportunities missed. On the other hand, some investors experience regret immediately after making spontaneous decisions.

SMAs, as opposed to buying and selling shares directly yourself, may take this psychological risk off the table.

Most SMAs will consist of a range of shares chosen using a well-recognised and rewarded process. SMAs tend to be built on the back of investment fund strategies that have withstood multiple economic and market events. Analysing this past track record should provide ample evidence that experienced managers are able to manage risks in their portfolio that will be rewarded over time.

SMAs can provide investors with certain psychological benefits as well as the better known financial benefits. I believe investors should take into consideration these additional advantages when assessing the appropriateness of SMAs and the role they play within an overall financial strategy.

Find out more information about SMAs

 

1 JBWere Investment Trends SMA Report 2015.

2 Prospect Theory: An Analysis of Decision under Risk by Daniel Kahneman and Amos Tversky, Econometrica, 47(2), pp. 263-291, March 1979.

3 Langer, Ellen J. Journal of Personality and Social Psychology, Vol 32(2), Aug 1975, 311-328.

4 Regret and its avoidance: a neuroimaging study of choice behavior. Coricelli G1, Critchley HD, Joffily M, O’Doherty JP, Sirigu A, Dolan RJ. Nat Neurosci. 2005 Sep;8(9):1255-62. Epub 2005 Aug 7.

 

Important information

This document is issued by nabInvest Capital Partners Pty Limited (“NCP”) (ABN 44 106 427 472, AFSL 308953), a member of the National Australia Bank Limited (ABN 12 004 044 937, AFSL 230686) (“NAB”) group of companies (NAB Group). An investment in any product or service offered by a member company of the NAB Group does not represent a deposit or liability of, and is not guaranteed by, NAB or any other member of the NAB Group.

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