6th July 2012
Why investor sentiment is still down and women may be smarter investors
A new Equity Preference Index developed by Colonial First State (CFS) and the University of Western Australia (UWA) Business School provides intriguing further insights into the Reserve Bank of Australia’s (RBA)’s recent finding that “Australian households’ appetite for risk has declined following the global financial crisis and economic slowdown in 2008–2009.”
The Equity Preference Index tracks the proportion of retail (non-advised) investors’ allocation to equity funds each month. Tracking is done on a cumulative basis, which allows trends towards or away from equity to be observed. The EPI is based on investors’ actual decisions so it is arguably more reliable than indices of investor sentiment based on survey data.
Can investors predict market movements?
Are Australian retail, unadvised investors smart? A famous (amongst finance academics!) paper; “Is money smart? A study of mutual fund investors’ fund selection ability”, published in the Journal of Finance, found weak evidence that investors can identify funds that subsequently outperform. The question the EPI allows us to address is whether Australian retail investors can predict market movements. There are two forms of measuring investor tendency to allocate into equities; one is the ratio of net switches into equity (switches into equity less switches out of equity) over the total value of switches for all products/asset classes. The second measure extends the scope of the first measure by netting applications and redemptions and switches.
Intriguingly, the switches measure shows investors switching out of equities after December 2005 and for the majority of the period leading to the GFC despite the strong gain in the Australian equity market as shown by the All Ordinaries Index over that time. Amongst the investors who switched their allocations, a minority of all retail fund investors, there appears to have been a presentiment that the “good times” were not going to continue.
By April 2008, the All Ordinaries had fallen substantially from its peak in October 2007 and net switching out of equities became dramatically more pronounced. This continued until February 2009 when an equally striking preference for equities amongst switching investors followed in the wake of the large and quick turnaround in the performance of the All Ordinaries Index. It is noteworthy that after February 2009 net switches into equity tended to track the All Ordinaries closely, albeit with a lag.
Little sign of improving sentiment
Looking at the aggregate index, investors continued to move new money (net of redemptions) into equities up until May 2008, when the GFC escalated significantly. Equity preference then declined until April 2009 before resuming with the market rebound. Since early 2010 there has once again been a decline in preference for equities which accelerated in August 2011 when the sovereign debt crisis in Europe and US economic concerns were reignited. Despite improvements in equity market returns since December 2011 and signs of improved policy making at this stage (as of end January 2011) there had been little signs of improving investor sentiment.
Evidence that women are smarter? Equity preference by gender
The next part of the analysis seeks to look at equity preference by gender. This reveals a stark difference between investor sentiment between the genders for switches into / out of equities and new money in / out of equities.
The analysis shows females tend to track the market with switches into equities rising with the equity market. Women appear more sensitive to current changes in market performance than males. In effect females who switch, exhibit a tendency to lock in their losses and their gains. Males appear more circumspect from 2005 to 2009 with an overall switch out of equities, but on aggregate a stronger preference for equities then females. Generally men follow leads in the market more closely than women who are more cautious.
When the analysis is extended to include the aggregate equity preference index (ie applications, redemptions and switches), the dynamics change slightly. Females switch out of equities and reduce equity allocations in concert. For males this is a trend that does not occur till the GFC. Males continue to allocate to equities relatively more than females in their allocations with females overall showing a more severe allocation out of equities than male counterparts post GFC.
This generally follows historical patterns. It could also reflect changing labour market trends. Since the GFC, female employment has been slower to return then male employment. Since the trough in the labour market in June 2009, unemployed men have fallen by 17% compared to unemployed female which has risen by 3%. This cautious behaviour of women in particular must be seen with rising concerns about lower female superannuation balances with growing risk of not meeting retirement objectives, in the absence of increased savings.
That said, it is far from obvious that women’s investor behaviour has served them poorly. Women have fared better than men when the market has crashed because of their cautious approach. Whether this approach reflects a more considered, “smarter” asset allocation approach or just a natural conservatism is the billion dollar asset allocation question.