Here’s a controversial thought: men and women are different.

Not in terms of strength, temperament, intuition, or any of those things—not for the purposes of this article, anyway. They’re different in terms of how they invest.

A spate of studies looks at gender-based financial behavior. One finds that women tend to be more involved in the family balance sheet. Just over 60% of women manage the household checkbook; 58% pay the bills; 44% (versus only 23% of men) oversee the budget.¹

Yet only 15% of married women take primary care of the family investments. This in spite of the finding that, when it comes to choosing investments, women tend to be more diligent. Surveys suggest that while men chase “hot” stocks and mutual funds, women spend almost twice as much time researching mutual funds before investing. This could be due to greater caution on the part of women, or, depending how you look at it, greater hubris on the part of men. A ShareBuilder survey reports that 12% of women versus 21% of men feel “confident” about their investment abilities.

Whatever the cause, it pays off. Finance professors Brad Barber and Terrance Odean find that—though women hold less risky portfolios than men, pursuing (and expecting) lower returns—after adjusting for differences in risk, women achieve bigger returns.

Before we giggle or grunt, let’s make a larger, gender-neutral point: Overconfident investors trade too much. Indeed, Barber and Odean take pains to assure us that gender is but a convenient statistical tool—”a variable that provides a natural proxy” for the real factor at work, overconfidence. Psychology researchers have long held that men are more prone to overconfidence, so we’d expect them to trade more aggressively. We’d also expect this trading to increase costs, which in turn should reduce performance. To test this, the authors set out to determine if the population that is naturally overconfident earns lower average returns than the population that isn’t. (See? It’s not about men and women at all!)

The professors analyze a huge database of brokerage accounts from the 1990s. They find that married men trade 45 percent more than married women and earn annual risk-adjusted net returns that are 140 basis points lower. Moreover, the differences widen when the sample isn’t married people: Single men trade 67 percent more than single women and earn annual risk-adjusted net returns that are a full 230 basis points lower. Worse still, the men have average turnover of 77% per year(!) while the women have average turnover around 53% per year (it seems both groups need advisors instead of brokers).

If you believe the stereotypes, these results shouldn’t surprise you. Men are supposedly brought up to embrace competition and risk. This translates into winning short-term sprints, not waiting out marathons in broadly diversified strategies. Sure, research is great, but guys don’t like to ask for directions. Women, on the other hand, are more likely to avoid knife-fights, Scotch, or taking a flyer on some dicey stock or hedge fund. The research shows they’re also more likely to seek out data and expert help, and to take their time before committing assets.

It also turns out that non-experts of either sex tend to make investment decisions poorly, and too often. We see this in the returns of retirement accounts: Defined Benefits (DB) plans run by professional investors historically outperform Defined Contribution (DC, or 401k) plans in which participants call the shots—and by about 200 basis points per year.²

It’s hard to blame the participants. 401(k) platforms are usually salad bars that, if anything, stress fund selection and not asset allocation. And while companies might provide education to participants, they rarely offer the tools available to professionals. Where DB plans use Monte Carlo simulations, optimizers, and multifactor models, such methods are unavailable to DC participants, and would be perplexing-unto-useless if they were. After all, most participants already have jobs. A 401(k) plan might offer the best education program in the world, but how many participants have the time or inclination to moonlight as the next Warren Buffett?

You might reasonably think the returns differences between DC and DB are fee-based: DC plans offer mutual funds, which, pound-for-pound, charge greater fees than separately managed DB trusts. Unfortunately, that’s just the start. DC plans tend to favor active funds, which usually charge more than passive funds. You might not view this as a distinction either, since DB plans also favor active managers. But to the extent employees are left to decide which funds to choose, they’re likely to base their choices on recent performance, which would lead 401(k) investors into funds that have higher average fees even by active management standards.

When DC plans first got legs in the 1980s, participants were risk-averse. As late as 1990, DB plans held 60% of assets in equities while DC plans held only 45%.³ Following the last couple of bull markets, this changed: DC participants jacked up their equity exposure. The key word here is “following.” Leading into the 2008 market meltdown, 401(k) plans held upward of 70% of total assets in equities. It’s tough to escape the conclusion that they “under-invested” in equities right before bull markets and “over-invested” in equities right before bear markets. We can debate whether expert advice would have helped (after all, “experts” populated the DC plans with expensive active funds to begin with), but the data suggest that DB plan allocations were more stable through the ups and downs of the last two decades.

Like practicing law, investing is a skill. Laypeople should no more manage their own portfolios than defend themselves in court. In the investing skill-set, two traits that clearly pay dividends are patience and knowledge. Whether they know it or not, most people benefit from prudent, professional advice. Gender and plan studies reinforce the role of advisors and sponsors, with a few added insights:

When both partners are involved, a family’s portfolio can benefit. As a broad generality, men might be more amenable to taking the risks necessary to meet goals, while women might be more amenable to a non-active investment philosophy, appreciate its pedigree, and value the broad diversification of a global strategy. Both traits motivate and bolster investors through good and bad markets. They’re a winning combination.

Investors benefit from an approach that maximizes expected return for appropriate levels of risk. Multifactor investing directly addresses this task. Advisors and sponsors that embrace its tenets are better equipped to help investors avoid the pitfalls of emotional trading. Sponsors can structure pre-allocated options and risk-assessment tools for DC plans. Advisors can do likewise for clients, and those with suitable businesses can consider adding smaller DC plans to their client rosters.

In all cases, a multifactor framework helps resolve the age-old conflict between our impulse to take risk and our desire for prudence and scientific authority. In the end, people of both genders become better investors.

June 2010
Market Sentiment vs Economic Reality

Investors who pay close attention to daily media headlines about the financial markets could be excused for thinking the world is coming to an end. But there’s a flipside to this story.

To be sure, current concerns about sovereign debt and the damage to public sector balance sheets wrought by the financial crisis of 2008 are very real. But markets have a way of working through these risks, as we are seeing now.

In the meantime, amid all the doomsday talk, it’s worth reflecting on the fact that securities markets and the real economy are different things. And on the latter front, there is much more encouraging news at the moment.

In its twice-yearly report on the global economy, released in late May, the Paris-based Organisation for Economic Co-operation and Development said the world economy is recovering faster than expected from recession.1

The OECD, which brings together 31 developed economies, lifted its projections for global economic growth to 4.6 per cent in 2010 and to 4.5 per cent in 2011. In the previous report, released in November, its growth assumptions were 3.4 per cent and 3.7 per cent respectively.

Interestingly, the new projections are higher than the average annual rate of growth the global economy registered in the decade before the crisis.

It should be noted that the organisation did point to risks around these growth forecasts, particularly from instability in sovereign debt markets (as we are seeing now) and the risk of overheating in emerging markets.

But the overall message was one of cautious optimism. Unemployment looks to have peaked, the OECD said, international trade flows are rising again and many governments are beginning to repair their fiscal positions.

It is also worth pointing out that while Europe and the US sort out their problems, the Asia Pacific region is booming, thanks to the rapid industrialisation and modernisation of China and India. Latin America has also emerged from the global crisis in relatively good shape, a fact noted recently by the International Monetary Fund in praising policy reform there.2

Australia has been a beneficiary of the strength in emerging markets, with strong commodity prices underpinning incomes here. In fact, so rapid has been the expansion that Australia’s central bank has led the world in raising official interest rates, six times since October.

Even for Europe, there is good news. The weaker euro is making European companies more globally competitive. For example, analysts have noted that carmakers Peugeot Citroën and Volkswagen have joint ventures in China, the world’s largest auto market, and each benefit from importing cheaper components from their home market.3

On the policy front, also, the IMF has expressed confidence in the recovery thanks to the unprecedented cooperation in the international community since the crisis began, through forums such as the Group of 20.

“We have seen China adopt a massive stimulus package geared towards reactivating internal demand, and moving away from its export model, and US consumers have started saving more, which also shows some change,” IMF chief Dominique Strauss-Kahn said in a recent visit to Brazil.

“One must not forget, however, that the US consumer is currently the engine of worldwide growth so you can’t find a solution to the problem overnight. It is a lengthy process that will only take place gradually.”

The point of all this is that there are grounds for hope and that the underlying economic situation is not as bad as the financial headlines of gloom and doom might sometimes portend.

For the ordinary investor, the takeout is that financial markets are fairly efficient in accommodating bad news, so that by the time you read about one event the markets have gone onto worrying about something else.

In the meantime, policymakers globally are working to ensure the world economy emerges from the crisis in better health. And there are indications from the economic data that the recovery is happening. While Europe and the US work through their problems, much of the rest of the world is doing relatively well, particularly the emerging markets in Asia and Latin America.

At the end of the day, sentiment is one thing, reality another.

1. ‘OECD Economic Outlook’, May 2010

2. ‘Latin America Helps Shape Global Economic Recovery’, IMF Survey, May 2010

3. ‘Peugeot, Volkswagen Boosted in China by Weaker Euro’, Bloomberg, May 26, 2010

*

Time for some perspective

The recently published Barclays Equity Gilt 2010 study seemed to turn everything we know about risk on its head. In revealing the 10-year real – that is, inflation-adjusted – return from various different asset classes, it showed equities have dipped 1.2%, while corporate bonds have delivered the highest return, at 2.9% per year. Gilts added 2.6% per year.

On this basis asset allocation should be simple. If risk doesn’t pay over the longer term, why take it? Stick everything in gilts and corporate bonds, collect coupons and never be troubled with the stockmarket again. Actually, given that cash paid 1.8%, is an extra 1% per year really the risk of investing in corporate bonds?

If only it were that easy – but there are a number of reasons why it is not. Certainly, there has been a progressive de-rating of developed market equities over the past 20 years. One European manager recently said he could remember the time when high-quality, dividend-paying European blue-chips commanded valuations of 30x or 40x earnings. That has been progressively eroded.

But investors should bear in mind that, 10 years ago, the UK was at the top of the technology bubble. The overall level of the market was skewed by a number of companies on valuations that were unprecedented and, rightly, have never been matched. A more accurate picture could be gleaned by stripping out the bubble stocks and focusing on what has happened to equities not caught up in that “irrational exuberance”. The de-rating would still be in evidence, but it would not be as profound.

Equally, there is still one, big argument against using the study to determine future asset allocation. If the credit crunch has taught us one thing, it is that past performance is poor a guide to the future. Financial models suggested the credit crunch was a one-in-a-million chance based on past performance but it still happened.

If in 2000 you had looked at the previous 10 years and projected into the future, every model would have told you that equities would have been the place to be for long-term returns. Yet … here we are. Investors have to be cleverer than that.

At the moment, cash pays nothing. Few savings accounts even match inflation. Gilts look very expensive. They have been artificially supported by quantitative easing and it is difficult to know where support will come from in the future. Corporate bonds have had a strong run. Equity valuations, on the other hand, still look relatively modest compared to other asset classes and – for what it may or may not be worth – to their own history. If anything, these figures should suggest it is a time to buy, rather than to abandon, equities.