APAC Investment Behavior

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Raveena Mital's picture

THE APAC BEHAVIOR

Financial decisions are driven by more than just mathematical analysis. They are based on human behavior. This is what the emerging field of behavioral finance has held to tackle: common biases/emotions that instigate investors to make irrational choices. The ultimate aim is to find a pattern in decision-making that can predict how the market will react. However, can this study be used to describe the choices made by APAC (Asia Pacific) investors? Certainly. Firstly, Asian financial markets are one of the largest in the world, making differing behaviors capable of causing significant impact. Secondly, with highly diverse cultural, social and financial environments, Asian investors cannot be classified as robots that make the same rational decisions; they rather possess cognitive biases that compel them to make certain investments over others. This is why scholars such as Robert J. Shiller emphasize that financial downturns can be much difficult to control than anticipated. This essay argues why this is the case in terms of the various behavioral patterns exhibited by APAC investors. In general, the root-word governing APAC investors’ decisions, is “OVER”; that is, “over”-confidence, “over”-trading, and “over”-assumptions.

 

“OVER”-APPROACH

            To begin, APAC investors are prone to be affected by over-confidence in trading. This is due to the fact that many Asian cultures (such as the Chinese culture) promote the idea of collectivism as opposed to individualism.[i] Although teamwork for economic growth is a wise model because “two-heads-are-better-than-one”, it also instills an extra sense of security in people’s minds. In terms of financial markets, this relief of always having government/state intervention incase anything goes wrong leads investors to become overconfident and thus more risk-taking. As surveyed by Barclays, Asian HNW (high-net-worth) individuals have a higher risk tolerance level than the global average, leading them to become stressed when markets turn volatile.[ii] These regions’ banks also have the tendency to become greatly leveraged than necessary, exposing themselves to serious risks of default. As Schiller points, this is what happened in 2007, where the FHA had leveraged 30 to one, sinking under billions.[iii] It will not be surprising to find this behavior among Asian regions, when the subsidized sector competes with the private sector in evaluating risky mortgages.

            The impact of all this overconfidence is market crisis. Investors turn like gamblers, assuming much more risk than they really want and making them default when things take the unexpected route. Sometimes amateur investors also rely on this overconfidence to choose investments that are only designed for the financially knowledgeable. This is what drove inexperienced retired workers to invest in Lehman mini-bonds. What happened afterwards was a mere catastrophe.

            The next “OVER” impacting APAC investors, is over-trading. Drawing from Barclay’s research, about 45% of Hong Kong investors believe they need to frequently trade in order to perform well in the market.[iv] In reality, there is really no such formula that dictates one must trade a minimum amount per day to well. In-fact, many traders are able to secure millions of dollars by only one or two trades. To top this off, APAC investors also have been seen to trade in herds in the market, particularly in China where all domestic investors plunge into investing in A-shares during high times.[v] Hence, this over-trading in herds leads to high market volatility as numerous investors start buying/selling hundreds of shares instantaneously. Sometimes this may be triggered by a newsflash, announcing a change in a company’s CEO for example, that leads many investors to react immediately by trading in the market. Such is magnified by the online trading platform that has led to the creation of the HFT (high-frequency-trading) market. HFT algorithms readily combine sophisticated technology to make it possible for investors to trade in a fraction of a second. Although this may sound efficient (in the sense that investors do not waste time reading news first and then responding), it creates dangerously volatile markets when investors decide by sentiments. This was the case in the “Flash-Crash”, which made the market plunge down when several investors shorted their securities too quickly. This explains that technology-based trading platforms like the HFT are only perfect for robotic-investors. For APAC investors, who suffer from behavioral biases of over-trading in herds, these may create problems when intuition is given too much importance.

            The last “OVER” bias discussed for APAC investors, is “over-assumption.” Asian investors are known to make major financial choices based on their own assumptions; whether it be assumptions on a particular stock or the market in general. The Barclays Survey reveals that Asian investors perceive cash and real estate to be the least-risky assets classes and thus apportion their positions accordingly.[vi] However, this may not sound rational to every person because many Asian countries like Hong Kong, China and Singapore are forming huge property bubbles. Nevertheless, investors continue to ignite the fire by putting more money in property, assuming that home prices will never fall. This again goes back to Shiller’s point that financial tsunamis can be difficult to control when humans employ too many assumptions in decision-making.

            As the yearly CFA Institute survey reveals, APAC investor confidence is on an even more high for 2014. 56% of such individuals are highly optimistic on economic growth this year, with Hong Kong professionals at the top end of the spectrum.[vii] The ironic part is that most people recognize the risks of asset bubbles and fear weak conditions and political instability in their own economy. Yet, the real estate market is not being allowed to draw down. Moreover, investors are not starting to decrease the trade numbers to a moderate level. Although diversification has proved to be a sound solution to reduce unwanted risk, people’s portfolios are still concentrated with the most volatile assets. With that even government efforts, such as increasing the stamp duty or limiting visas based on volatile investments, have not had any drastic impact. Why is this? This is because individuals continue to be driven by cognitive biases with their mathematical analysis that does not always result in the most rational decisions.

            Overall, just like the diverse Asian environments shape different cultures, they also result in investors that have a varying degree of rationality. This is because the theories of behavioral finance readily come into play, with APAC investors generally affected by the “OVER” approach- overconfidence, overtrading, and over-assumption.

            This is not to say that this is a serious flaw in this group of investors. In-fact, APAC investors have had a big hand in contributing towards the rapid growth of Asian financial markets, despite the crisis in 1997 and gradually emerging economic growth. For example, China has undergone so many changes and instability post its economic reform; yet, it continued to open and grow its financial sector with support from Hong Kong. Japan, although being severely shaken by the 2011 tsunami, is still seen as a healthy investment prospect for 2014. Similar success stories follow for other Asian regions. In-fact, in some sense the APAC investors’ cognitive biases has actually helped to develop the financial markets. For example, the overtrading behavior has triggered mathematicians and financial analysts to look for technologically rich algorithms, leading to the creation of the HFT market. This has also encouraged the media to quickly report current news on both local and overseas companies and the stock markets to be updated on a regular basis accordingly. All this would not have been possible if investors only took into account pre-existing formulas.

            However, just like everything, even these behaviors have their own drawbacks and one major one is that they do not prevent financial crisis from happening. Asset bubbles continue to form, just like Shiller describes in his work. Then why do investors still not refrain from such actions? This is because each one believes that his/her few transactions will have no major impact in the market. Such investors think that they are unique to be embedded with such assumptions or overconfidence on making investments in vulnerable markets. For example, investor A may have the idea that it is irrational and risky to place too much money in housing when property prices are shooting up in a bubble; however, he would still follow his instinct in the hope that another investor (who is perfectly rational and not willing to invest money in real estate) will do something that offsets his action, giving investor A personal gain at the end. This is an incorrect approach because in reality if all such investors start getting driven by personal motives to make irrational choices, financial markets will suffer from volatility and downturns at the end.

            Thus, amidst all this, it is actually the investors who are able to sense this irrational behavior by others that are able to make money by pursuing strategies contrary to beliefs. But a healthy financial market, not just for the APAC region but worldwide, will only flourish when investors abstain from relying too much on cognitive bias and the government & media have knowledge on the types of solutions sought to combat financial crisis.

References: 

[i] Kenneth A. Kim & John R. Nofsinger. (2008). Behavioral finance in Asia. Pacific-Basin Finance Journal: USA.

[ii] Peter Brooks, Behavioral finance – investor attitudes to wealth- Asian Wealth Management and Asian Private Banking, Hubbis, http://www.hubbis.com/articles.php?aid=1308276548 (January 20, 2014).

[iii] Robert J. Shiller, The Financial Fire Next Time, Project Syndicate http://www.project-syndicate.org/commentary/robert-j--shiller-asks-why-i... (January 29, 2014).

[iv] Peter Brooks, Behavioral finance – investor attitudes to wealth- Asian Wealth Management and Asian Private Banking, Hubbis, http://www.hubbis.com/articles.php?aid=1308276548 (January 20, 2014).

[v] Kenneth A. Kim & John R. Nofsinger. (2008). Behavioral finance in Asia. Pacific-Basin Finance Journal: USA.

[vi] Peter Brooks, Behavioral finance – investor attitudes to wealth- Asian Wealth Management and Asian Private Banking, Hubbis, http://www.hubbis.com/articles.php?aid=1308276548 (January 20, 2014).

[vii] Patrick Yu, Investment Professionals in Asia Pacific Show Tempered Optimism on Economic Growth in 2014, http://www.antaranews.com/en/news/91852/investment-professionals-in-asia... (February 1, 2014).