Retail and institutional investors are exhibiting behavior that is at odds with their investment goals, according to a new study by State Street's Center for Applied Research.
"The Influential Investor: How Investor Behavior is Redefining Performance" was based on 12 months of research and input from more than 3,300 investment management industry participants. The research highlighted that most retail investors believe preparing for retirement requires aggressive investing, yet 31 percent of their assets are in cash. Institutional investors love alternative investments but admit that they don't have a deep understanding of these assets.
"While investors have never been as aware of their micro and macro environments, they are exhibiting behaviors that are divorced from their stated investment objectives," said Kelly McKenna, global head of the State Street Center for Applied Research.
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Against this backdrop of investor disconnect between behavior and goals, the study found that investors identified performance as the most important metric for determining the value of their investment providers and the greatest weakness of their investment providers.
The study revealed that when it comes to performance, one size no longer fits all.
"Current monolithic benchmarks based on relative performance to peer groups or indices serve the provider," said Suzanne Duncan, global head of research for the Center for Applied Research. "The investor's view of value is now more complex and reflects his/her own personal blend of strategies and objectives. In today's investment reality, the investor is the benchmark when it comes to defining performance."
Based on these findings, the Center for Applied Research advocates for fully transparent performance models that focus on long-term sustainability of returns, defined in terms of value to the investor. Over time, this new model for success will help to reduce barriers to healthy decision-making and will lead to improved performance.
The study also found that investors' seemingly irrational behavior is actually a rational response to a number of factors impacting the current global investment environment:
- Major economic trends, including a steady increase of national debt worldwide, tighter correlations across global markets, and a rise in systemic risk;
- Mistrust of their primary investment provider to act in their best interest, stemming in part from lack of value delivered versus fees charged. Only one-third of investors believe their primary investment provider is acting in their best interest; and
- Impediments from politics as well as new financial regulation that most investors believe will be ineffective and expensive. Sixty-four percent of investors believe that regulation won't help address current problems and sixty-two percent believe the cost will be passed on to them.
The Center for Applied Research proposes a four-component performance model in which key value drivers become the building blocks for "personal" performance. Two components – alpha seeking/beta generation and downside protection – are related to market forces and are common to most investors. The other two components – liability management and income management – are risk exposures unique to each investor.
McKenna concluded, "While the future of the industry will be determined by the actions investors take, the investment community has clear opportunities to work together to create better solutions for this new economy."
The Center for Applied Research (CAR) is an independent think tank comprising a global team of researchers located across the Americas, Europe/Middle East/Africa and Asia Pacific. CAR conducts targeted research designed to provide clients with strategic insights into issues that will shape the future of the investment industry.
State Street Corporation is one of the world's leading providers of financial services to institutional investors including investment servicing, investment management and investment research and trading.
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