Ensuring Investment Suitability ©2016 Distribution Technology Ltd. All Rights Reserved. Paul Craven, Behavioural Economist Dynamic Planner Annual Conference

Ensuring Investment Suitability: A Behavioural Perspective Paul Craven Distribution Technology 2016 The Brewery, Chiswell Street, London March 2 nd, 2016

A Question Source: Tanya Khovanova, 2009 Which is the odd one out?

Your mind plays tricks! The Disappearing Yellow Dots Source: Yoram Bonneh The Smith-Kettlewell Eye Research Institute (2001)

 Unreliable economic models?  Incentivisation?  Behavioural biases? Why were none of the 62 recessions in predicted in the previous year? Source: Ahir and Loungani, “Fail Again? Fail Better? Forecasts by Economists During the Great Recession” (2014), Consensus Forecasts

Today’s Session 1.The Mind 2.Biases 3.Enhancing Skills We all make mental short-cuts

Dual process model of the brain System 1 fast, unconscious, reactive, emotional System 2 slow, conscious, analytical, rational

Human rationality System 1 v System 2? Source:

Biases  Evolutionarily successful: 150+ modern day biases  You / Colleagues / Clients  What biases are you likely to encounter in your investment? Probability & belief Decision-making Social Memory

1. The Herd Instinct Recent Bubbles (Jan 1998 = 100)(Jan 2003 = 100)(Jan 2006 = 100) “History does not repeat itself, but it does rhyme” Mark Twain Source: Dr Jean-Paul Rodrigue, Hofstra University

Investment markets Humans are emotional! Source: Westcore Funds / Denver Investment Advisors, 1998 Point of maximum financial risk Point of maximum financial opportunity

2. Confirmation Bias “We must not do the wrong things for the right reason…” Ron Liddle  Politics  Question Time October 15th, 2015

2. Confirmation Bias “Still a man hears what he wants to hear and disregards the rest” Paul Simon  Politics, Business and Investment  The Sunk Cost Fallacy Source:

Blank Sheet of Paper Approach “How many of us genuinely do this in our individual or group decision making?” “Most of our mistakes come from using System 1 when we are in fact thinking we are using System 2.” Nassim Taleb

Charles Darwin’s Pros and Cons of Marriage Charles Darwin and Emma Wedgwood. had a long and happy marriage ( ), producing 10 children Source: The Correspondence of Charles Darwin, Volume 2:

3. Hindsight Bias  We are all experts with hindsight  Creeping determinism Further Reading: Superforecasting by Philip Tetlock. (2015)

Source: Michael Mauboussin, CSFB. The Luck vs. Skill Continuum Where does the investment industry sit? From Roulette to Chess: the luck/skill continuum PURE LUCK PURE SKILL Further reading: The Success Equation by Michael Mauboussin

Decision Making ‘Process’  “How systematic are you and your clients?” e.g. Checklists make for smarter, more systematic decision-makers The importance of Dynamic Planner

A Behavioural Perspective: Benefits Self awareness and self discipline… …leading to more effective decision- making Self-awareness as individuals and in groups …leading to enhanced business relationships …and improved understanding and communication….should result in better investment decisions. A more systematic decision making process…

Summary Our psychology determines our behaviour:  We all make mental short-cuts  Understanding human psychology gives us a major advantage “If you don’t know who you are, the stock market is an expensive place to find out…” Adam Smith

Thank you very much! Please stay in touch:

Brisbane Source: Testing The Wisdom of Crowds Is there the next Warren Buffett in the room?