How is COVID-19 changing the way we invest?

Dear friend of AQUMON, 

Global financial markets posted a strong rebound last week mainly led by US stocks. The US’ S&P 500 continued its impressive rally (+3.26% last week and +8.58% year to date) which now includes the best August performance since 1984: 

To put this into perspective, the S&P 500 has gained 56.87% since the market bottom on March 23rd. The Euro Stoxx 50 was +1.71% last week and -11.47% year to date. The spread between US and European stock YTD returns now stand at an enormous +20.05% as of August 28th. Hong Kong’s Hang Seng Index was also +1.23% last week and still -9.82% year to date.

AQUMON’s diversified ETF portfolios were -0.11% (defensive) to +2.25% (aggressive) last week and +2.29% (defensive) to +5.81% (aggressive) year to date. AQUMON’s SmartGlobal HK ETF portfolio with more regional exposure to Hong Kong/China is +1.07% (defensive) to +10.14% (aggressive) year to date. Portfolio drivers last week were Chinese growth stocks (+5.24%), US technology stocks (+3.39%), US stocks (+3.26%) and Chinese stocks (+3.86%). Laggers were US investment grade bonds (-0.48%) but most safe assets like bonds were relatively flat last week.

At AQUMON, the growth we have seen in new clients and people interested in investing has shot up enormously during COVID-19. This mirrors similar growth and interest patterns we see on investing platforms and robo advisors overseas. Although growth is a happy thing, we also noticed a change in behavior amongst global investors due to a mix of psychological, emotional and technological factors experienced during COVID-19. We feel investors should be aware of these unconscious behavioral changes. To improve in anything we need to first identify the problem(s) and we feel by understanding the takeaways below and making subtle changes, you can more easily achieve your investment objectives.

Takeaway #1: Investing in “emergency mode” is a losing proposition for investors

As global COVID-19 cases cross the 26 million mark, it can be tough to remember that it only started to impact our daily lives 6 short months ago. Back in early March COVID-19 fears sparked consumers to panic buy supplies and there was even a heist in Hong Kong where 3 men attempted to steal 600 rolls of toilet paper. Still remember that? The point we are trying to make is people do some strange and irrational things where they are under the pressure of an emergency situation. 

COVID-19 is by definition an emergency of global proportions. Governments also sprung into “emergency response mode” back in February and March. In an attempt to stop the spread of the virus we saw for the first time in history country-wide lockdowns with borders closed off and citizens being ordered to stay at home. Although this is the ‘new normal’ now and widely accepted, this would have been crazy to hear back in 2019. Breaking down the psychology behind it, for all of us our singular focus came down to 1 thing: our survival. The simple objective was to escape the danger of the pandemic. Nothing else matters. ‘Now’ is more important than ‘the future’.

What we clearly see is that the time horizon for our decision making during an emergency situation gets compressed dramatically to just the immediate future. This is where it can be problematic for investors. When we are making investment decisions in a “emergency mode” situation we often make poor decisions like:

1) Panicking and reducing our long term goals of ‘growing our wealth’ over time to simply try to ‘preserve it’ and cashing out.

2) Irrationally switching all/most of your assets into ones that you feel are ‘safer’

3) Do absolutely nothing

What should investors do: We strongly believe good investment decisions are made when you understand what you are up against (like the behavioral bias of investing during an emergency situation) and in a calm and collected manner. Having ample savings or liquidity on the side along with calmly extending your investment horizon will also be helpful ways you can stay rational when other investors are making poor panic-driven investment decisions.

Takeaway #2: Investors are more optimistic than they realistically should be

There’s nothing wrong with looking on the bright side of things (we’re highly positive people at ourselves) but after over a decade of strong stock market returns this will likely over-inflated our expectations of future returns. Investors need to be careful because this will often result in investors taking on more investment risk than they should and furthermore being discouraged by their investment experience not meeting their expectations (and illogically deciding not to continue investing).

A recent Q2 2020 study commissioned by British asset manager Schroders found 66% of the investors said they believe the negative economic impact of COVID-19 will be felt over the next 6 months to 2 years with a further 21% of respondents saying it will last beyond 2 years. Even though financial markets are often not tied perfectly to the economic conditions, with the economic outlook amongst investors being more on the negative side, you would assume expected returns are also lowered. When asked what were their annual expected portfolio returns over the next 5 years investors responded they expected (on average) +10.9%:

Regionally speaking, US investors were most optimistic while European and Japanese investors least optimistic. The important thing to point out is compared against this exact same Schroders survey that was done the prior 2 years investors’ expected return actually increased +1.0% from 2018 and +0.2% from 2019! Given the pandemic proportions and its negative impact to our global economy this is quite surprising to hear. We feel it is more logical investors look at returns from longer periods that encompass both bull and bear markets to get a more accurate return expectations. Looking at the MSCI World Index (globally diversified stock index) average return since its inception on December 31, 1987 (over 32 years) is approximately +7.89% per year. Not far cry from investor’s expectations of 10.9% but much more realistic in a longer time horizon.

What should investors do: Although investors who stayed invested during the February 2020 selloff were handsomely rewarded after, investors also need to realistically taper down their forward looking return expectations so they aren’t unconsciously driven to ‘chase’ returns by taking on more investment risk than they should. Sticking to your investment plan and making smaller micro adjustments (if needed) is a far more effective strategy.

Takeaway #3: Don’t let 1 moment in time define your investment experience

We know it is easier said than done but for those of us who have been investing for 15+ years we’ve seen both primacy and recency bias (making decisions based mainly on first or most recent experiences and events) in past market downturns particularly with newer investors or non-investors. In certain extreme cases investors can be so paralyzed by their negative experience (resulting from losses and/or sensationalist headlines) that they swear off investing all-together. The same can be said for investors who are so intoxicated with their investment gains that they feel they are invincible (there are many ‘retail investor bros’ that currently may be subject to these kinds of biases).

Let’s find a good proxy event such as the Global Financial Crisis to see how this affected investors. Robo advisory firm Betterment did a study in 2018 recapping investor behavior after the global financial crisis of 2008. What they found was even for non-investors (who did not participate in the market and potentially just read the scary headlines) 66% of these non-investor respondents said they were less likely to invest as a result. But when further asked if they knew how the S&P 500 index performed during the subsequent 10-year period, 18% of respondents thought, after the negative experience, that it was down in value and 48% thought it remained flat. What happened in reality? The S&P 500 was actually up over +200% during that 10 year period.

What about those who did invest? 47% of all the respondents that invested and lost money in 2008 actually invested as much if not more money since then. Why were they still or more willing to invest? Maybe it has to do with these retail investors in reality not losing all that much during the Global Financial Crisis. Betterment surveyed 2000 people and found over 60% of the respondents lost less than US$9,999 (~HK$77,492) during the worst of the meltdown:

With a little bit of time and a systematic approach of periodically topping up many of these investors should have seen their portfolios return to a positive state. 

What should investors do: Knowledge is power. The important thing investors need to understand is that there will always be ups and downs (often ups are longer than downs even if the downs feel scary) when you invest. The key is to have a proper goal and approach to investing and try not to be influenced too much by a singular negative or positive experience.      

Takeaway #4: Herd mentality coupled with increased risk taking is a dangerous mix

With the rise of the retail investor during COVID-19 via trading apps like Robinhood the big question is do these smaller investors actually move the market? A note published by JPMorgan this week tracking the data from Robintrack seemed to confirm this. The research showed that as stocks increase in popularity among Robinhood investors, the returns of those stocks outperform their less-popular peers on a one-week and one-month basis. Meaning stocks that more Robinhood users held, outperformed their less popular peers stocks. So investors that followed other investors and ‘piled into’ these popular names benefitted. Sounds amazing right? Investors need to be careful they don’t fall into the bias of herd mentality (blindly following others) and also clearly understand the level of investment risk you are taking:

1) Herd mentality: The design of trading apps like Robinhood showcase a ‘leaderboard’ of the popular stocks and how many users own it (this has since been removed this week). Sort of like the blinking lights you see on top of the slot machines when you walk into a casino. They are hard to miss and many investors may just invest into ‘the most popular stocks’ which becomes a bit of a self-fulfilling prophecy in terms of performance. Risks remain since there are many instances where if you take an extra moment to think about the stock’s popularity the justification may not make much sense. For example stocks like recently bankrupt Hertz Global Holdings up +114% in 24 hours, Eastman Kodak up 1480% 3 days after announcing a pivot to drug manufacturing and Nikola Corp delivered US$36,000 revenue last year yet had US$31 billion (~HK$240 billion) in market capitalization back in early June (in comparison bigger than car giant Ford). How are these stocks doing now? The 3 stocks as of September 2nd have fallen 92.80%, 78.84% and 50.55% since investors piled in back in June. Although momentum is important, to see long term investing success, good fundamentals are key. So don’t just follow others blindly.

2) Understand what you are invested into: Beyond just stocks, be careful when accessing more complex investments like options (an options contract gives the holder the right to buy or sell an underlying security at a specific price until a certain date) which have considerably higher risk than traditional assets. These traditionally risky investments are now becoming easier to access for all investors via trading apps. Furthermore they have become more popular during COVID-19 due to its betting/gambling like nature and higher payouts (especially when coupled with leverage). The New York Times recently analyzed the amount of options that trading apps like Robinhood users used and found it was 9x more than at a traditional brokerage like E-trade: 

That’s a lot of risk most investors let alone less experienced investors should be taking particularly when markets are so volatile. 

What should investors do: There are many positives with technology but sometimes good things like investing naturally take time and understanding. Much like how you would logically “look before you jump”, investors should also “look” clearly before they invest and not just blindly follow others. Even if guided by a professional advisor, we suggest investors understand the amount of investment risk they are taking.

COVID has been a period of extremes which investors saw dramatic increases and decreases to their portfolios values overnight. We hope by highlighting these COVID-19 investing trends and bias that this can keep investors on track with their long term investing goals.

If you have any questions please don’t hesitate to reach out to us at AQUMON. We’re always happy to help. Thank you again for your continued support for AQUMON, stay safe outside and happy investing!

Ken

About us

As a leading startup in the FinTech space, AQUMON aims to make sophisticated investment advice cost-effective, transparent and accessible to both institutional and retail markets, via the adoptions of scalable technology platforms and automated investment algorithms.

AQUMON’s parent company Magnum Research Limited is licensed with Type 1, 4 and 9 under the Securities and Futures Commission of Hong Kong. In 2017, AQUMON became the first independent Robo Advisor to be accredited by the SFC. AQUMON’s investors include Alibaba Entrepreneurs Fund, Bank of China International and HKUST. 

Disclaimer

Viewers should note that the views and opinions expressed in this material do not necessarily represent those of Magnum Research Group and its founders and employees. Magnum Research Group does not provide any representation or warranty, whether express or implied in the material, in relation to the accuracy, completeness or reliability of the information contained herein nor is it intended to be a complete statement or summary of the financial markets or developments referred to in this material. This material is presented solely for informational and educational purposes and has not been prepared with regard to the specific investment objectives, financial situation or particular needs of any specific recipient