Bad Behaviors Thwart Performance

Recent research from UBS Global Asset Management suggests that when individual investors pursue performance over portfolio discipline, they underperform the market – and their own investments.

Frequently, the average individual investor’s performance (what an investor actually earns over that period) is much lower than the actual investment performance (the stated return) of his holdings—sometimes as little as half as much—and the variable seems to be the investor’s behavior, according Brian Singer, Regional Chief Investment Officer, Americas, and Head of the Global Investment Solutions (GIS) team for UBS Global Asset Management. The results were published in the first quarter 2007 edition of Current Perspectives, UBS Global Asset Management’s investment newsletter.

Taking a page from behavioral economics, Singer concludes that real-life underperformance stems not from what the investments did, but rather what the investor did. “The key variable appears to be how the investor behaved: when—and why—he bought and sold his investments,” the report says.

Institutional Investors

Although Institutional investors fare better, they are not free of all criticism. Institutional investors use greater discipline in their investment processes than do individual investors but, according to the research, they often follow their own form of performance-chasing, particularly in seeking “alpha,” or returns uncorrelated to a benchmark.

Singer says that the most frequently requested data series from institutional investors is the three-year historical track record, relative to the benchmark. “Almost every RFP requests this information, and we are dumbstruck by the degree to which it is used as an initial screen…. The reasoning is that three years is enough time to analyze a manager’s returns, and provides evidence that helps assess whether the manager is indeed skillful at beating a benchmark,’ the research says.

However, the report continues, three-year trailing performance is actually a fairly good contra-indicator of three-year prospective performance.

Adviser Actions

This research reinforces the importance of disciplined portfolio construction and, in fact, “a firm might conduct the best manager research since the invention of sliced bread, but if there is a lack of fiduciary accountability and the discipline to combine these managers for long-term performance, I believe the efforts are neutral at best, and destructive of value at worst,’ Singer says.

“I am pointing out how destructive both total-return-chasing and excess-return-chasing behavior can be,’ Singer says in the article. Therefore, he suggests, “the best offense may be a good defense,’ and tells advisers they can:

  • Create an outcome-oriented neutral portfolio allocation, based either on the investor’s risk tolerance or liability needs, or both
  • Adopt a theoretically sound core set of investment beliefs and stick to them
  • Appropriately define, understand, measure and manage risk
  • Not rely too much on historical performance, especially observed over short periods of time.

Although this advice appears logical, “putting them into practice may be harder than you think—for individuals and institutions alike,’ the article says.

The latest issue of UBS Global Asset Management’s Current Perspectives newsletter can be found online at