Standard Life Investments

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1 This presentation is intended for investment specialists only and must not be relied on by anyone else Standard Life Investments Behavioural Finance Applications October 2013

2 Overview Crowd Wise vs Crowd Foolish Man vs Machine Committee Decision Making Scenarios

3 Crowds can be wise The collective opinion of a diverse group can produce a better decision than an individual expert Individual irrationality and bias cancels out at the aggregate level Efficient markets characterised by information cascades and feedback loops Most investors unable to beat the market on a consistent basis for sustained periods 67% of US large-cap equity funds were beaten by the S&P 500 over the last 5 years Source: Morningstar

4 but also foolish 300 T T+12 T+24 T+36 T+48 T+60 T Herding: Follow the consensus rather than make an independent decision Decreasing volatility in a rising market may display lower levels of fear 100 T T+36 T+72 T+108 T+144 T+180 T+216 T+252 T+288 Nasdaq Index (Daily price, Rebased = 100 at 31 December 1998, data until 10 March 2000) 0 Market driven by emotional greed not company fundamentals Silver (Daily prices, Rebased = 100 at 28 July 2010, data until 28 April 2011) Bitcoin (Daily prices, rebased = 100 at 14 January 2013, data until 3 April 2013) (Upper Axis and R.H. Scale) Source: Datastream, BitCoin Charts, Bloomberg It has been more profitable for us to bind together in the wrong direction than to be alone in the right one. Nassim Taleb

5 Building decisions in layers 1. Layout of ant nest and target resource 2. Ants move randomly in the space 3. An ant that obtains food returns to the nest leaving a pheromone trail 4. Ants follow the pheromone trail until the resource has been depleted and returned to the nest

6 Evaluation of the GA reference pattern Source: Standard Life Investments Green spike: Reference pattern emerged; the market fell within 40 days Yellow spike: Reference pattern emerged; the market did not fall within 40 days Conclusion: The GA is not infallible but it can be a useful forward-looking indicator

7 Artificial neural network application Kohonen indicator applied to predicting equity market falls Stock money flow and price data are inserted into the Kohonen grid Whiteness : potential for sector to fall Source: Standard Life Investments

8 High frequency trading, value added? :00 20:30 20:00 19:30 19:00 18:30 18:00 17:30 17:00 16:30 16:00 15:30 15:00 14:30 S&P 500 (6th May 2010) S&P 500 (23rd April 2013) R.H.Scale HFTs account for 70% of transactions on Wall Street

9 Committees can be ideal James Surowiecki: The Wisdom of Crowds. Conditions for a wise crowd: 1.Variety of opinion. 2.Independent opinion formation. 3.Decentralisation: Actors share specialised knowledge. 4.Aggregation: Turn individual judgements into a collective decision.

10 Forward-looking scenario approach Defining features of scenarios need not be directly financial market related Economic Environmental Geopolitical Societal Technological Our subject matter experts translate scenarios into financial market impacts Quantitative techniques are then used to Add uncertainty to point forecasts Look for portfolio weaknesses Combining men (women) and machines

11 Risk & Structuring Fund Management Strategy Generating scenarios 1. Select scenarios < Each scenario assessed in turn > Team members are invited to submit scenarios A meeting is held to review candidates A subset is selected to go forward for analysis 2. Specify scenario drivers in market moves 3. Predict impact on strategies 5. Review strategy moves against expectations and repeat if necessary 6. Feed results into portfolio construction 4. Calculate implied returns It is better to be vaguely right than exactly wrong

12 Thematic scenarios Thematic scenarios QE bubble Abrupt end to QE EU disintegration Commodity shock Trade war China crisis 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% China crisis: Potential impact 2.00% 0.00% -50% -45% -40% -35% -30% -25% -20% -15% -10% -5% 0% 5% 10% Equity (-41.61%) Portfolio (-5.08%) Source: Standard Life Investments, Bloomberg

13 The information shown relates to the past. Past performance is not a guide to the future. The value of investment can go down as well as up. Any data contained herein which is attributed to a third party ("Third Party Data") is the property of (a) third party supplier(s) (the Owner ) and is licensed for use by Standard Life**. Third Party Data may not be copied or distributed. Third Party Data is provided as is and is not warranted to be accurate, complete or timely. To the extent permitted by applicable law, none of the Owner Standard Life** or any other third party (including any third party involved in providing and/or compiling Third Party Data) shall have any liability for Third Party Data or for any use made of Third Party Data. Past performance is no guarantee of future results. Neither the Owner nor any other third party sponsors, endorses or promotes the fund or product to which Third Party Data relates. **Standard Life means the relevant member of the Standard Life group, being Standard Life plc together with its subsidiaries, subsidiary undertakings and Associated companies (whether direct or indirect) from time to time." Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL. Standard Life Investments Limited is authorised and regulated by the Financial Conduct Authority. Calls may be monitored and/or recorded to protect both you and us and help with our training Standard Life, images reproduced under licence 13