Are A & B Different Shades of Gray? Source: Edward H. Adelson, 1995.

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2 Are A & B Different Shades of Gray? Source: Edward H. Adelson,

3 Are A & B Different Shades of Gray? Source: Edward H. Adelson,

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7 Prospect Theory & Framing System 1 (fast thinking, taking short cuts) operates automatically little or no effort no sense of voluntary control 6

8 Prospect Theory & Framing System 2 (slow thinking) effortful mental activities agency, choice and concentration Kahneman, Daniel. Thinking Fast and Slow. New York: Farrar, Straus and Giroux

9 Prospect Theory Mental Value Fear = 2xGreed Losses Gains Kahneman, Daniel. Thinking Fast and Slow. New York: Farrar, Straus and Giroux

10 More News = More Information? Business Week, August 13, 1979 The Death of Equities The Rebirth of Equities. Business Week, March 9, 1983 Bear Trap: Will Tech Stocks Sink the Rest of the Market and the Economy? Bailout Fails; Stocks Plunge. The New York Times, September 29, 2008 U.S. News & World Report, March 26, 2001 Bubble Fears as U.S. Stocks Break Records Get Rich.com Financial Times, November 20, 2013 Time, September 27,

11 Extrapolation In 1977, at the time of Elvis Presley s death, there were 170 Elvis impersonators worldwide. In 2000, there were 85,000 Elvis impersonators. At this rate of growth, statisticians predicted that by 2019, Elvis impersonators would make up 1/3 of the world s population. Source: Freemovement.org, November 13,

12 Attention Response & Framing S&P 500 Annual Returns ( ) Average Annual Return 11.4% Source: Prof. Robert Shiller data. Past performance is not a guarantee of future results. One cannot invest directly in an index. 11

13 Attention Response & Framing S&P 500 Index ( ) Calendar Years With Declines in Excess of 10% % -22% -37% % Return % -14% -26% % -44% -35% -11% -13% 10 Source: Prof. Robert Shiller data. Past performance is not a guarantee of future results. You may not invest directly in an index. Does not represent all market declines of 10% or more. 12

14 Redefining Risk and Return Meet Dr. Eben Otuteye and Mohammad Siddiquee Volatility is not a surprise. Volatility is neutral; it is just part of what the asset is. But you can turn it into risk if you mishandle it. Volatility Risk Source: Otuteye, Eben and Mohammad Siddiquee. Redefining Risk and Return in Common Stock Investment from a Value Perspective. 13

15 Risk Perceptions More Risk Doesn t Necessarily Mean More Return Potential Return % Low Low to Medium Medium Medium to High High Risk Level Source: Inspired by Marks, Howard. The Most Important Thing: Uncommon Sense for the Thoughtful Investor. New York: Columbia University Press Hypothetical illustration does not represent any particular investment. Actual results will vary. 14

16 Risk Tends to Diminish Over Time Range of Total Returns for U.S. Stocks Over Various Rolling Periods ( ) Range of Total Returns (Ann.) % 60% 40% 20% 0% -20% -40% -60% 2 Yr 5 Yr 10 Yr 20 Yr 30 Yr Source: S&P Dow Jones Indices, as of 12/31/15. U.S. stocks represented by the S&P 500 Index. Rolling periods represent a series of overlapping, smaller time periods within a single, longer-term time period. For example, over a 20-year period, there is one 20-year rolling period, eleven 10-year rolling periods, sixteen 5-year rolling periods, and so forth. Past performance is not a guarantee of future results. One cannot invest directly in an index. 15

17 Risk and Return: Ask Your Clients a Simple Question What do you expect returns to be next year for the stock market? Give me a range of outcomes. Do they include a negative number in their range? If not, have a conversation about expectations and short-term returns. Source: Jay Mooreland, 16

18 Extrapolation & the Impact of Emotions Investors don t do as well as they should. Annualized Returns for S&P 500 Index and Average Equity Investor (12/31/ /31/2015) % S&P 500 Avg. Investor Source: Dalbar QAIB, as of 12/31/15; Reflects the 20-year period ended December 31, Past performance is not a guarantee of future results. One cannot invest directly in an index. 17

19 Avoid This Behavioral Pattern! Source: Carl Richards at 18

20 Investment Process: The Essentials 19

21 Investment Policy Statement IPS Features and Implications 1. Client description (asset size, cash flow profile, liabilities) 2. Duties (asset class selection, manager selection, fee negotiation, monitoring) 3. Objectives (total vs. relative, real vs. nominal, risk objectives, fees/expenses) 4. Constraints (liquidity, horizon, taxes, legal, restrictions) 5. Asset allocation targets (asset class selection, acceptable styles, number of classes) 6. Rebalancing guidelines (frequency and rules) 7. Schedule for reviews (frequency and access) Source: CFA Institute report, Manager Selection by Scott D. Stewart, CFA. Dec

22 How Do We Make Decisions? Decision Rights Source: Jim Ware, CFA and Brian Singer, CFA. Decision Making: A Process Check for Investment Firms.

23 Evaluating Success Source: Russo, J. Edward and Paul J. H. Schoemaker. Winning Decisions: Getting It Right The First Time. 1 st ed. New York: Random House

24 Investor Stress Management Plan (ISMAP) 1. Positive activities they control 2. Investment plan 3. Sign it Source: MarketPsych and Brandes Investment Partners 23

25 Recognizing Potential Biases in Decision-Making Hiring or firing managers Adopting strategies/approaches that have had recent success or abandoning strategies that have fared poorly recently Confusing skill with luck when evaluating managers Looking at high returns without considering risks Source: Bob Maynard. Behavioral Finance: Pitfalls and Prevention for Plan Sponsors. Brandes Institute

26 Recognizing Potential Biases in Decision-Making Evaluating the products without evaluating the firm Avoiding high-risk investments because of perceived volatility Relying on skill in selecting a better-than-average manager Decisions where leverage is involved Source: Bob Maynard. Behavioral Finance: Pitfalls and Prevention for Plan Sponsors. Brandes Institute

27 Preventing Bias From Affecting Decisions Explanations in simple language Appoint a devil s advocate Establish and perpetuate a culture of debate Use quantitative evidence wisely Source: Bob Maynard. Behavioral Finance: Pitfalls and Prevention for Plan Sponsors. Brandes Institute

28 Preventing Bias From Affecting Decisions Create and follow a comprehensive investment policy Focus on the long term Pre mortem Document successes and failures Source: Bob Maynard. Behavioral Finance: Pitfalls and Prevention for Plan Sponsors. Brandes Institute

29 CFA Institute Recommendations In What Areas Should Investment Committees Focus? Review staff capabilities Set clear objectives and short-term risk tolerances Provide stabilizing, rational consistency Maintain stable committee with terms of 5 to 6 years, renewable once Achieve average manager tenure of 10 years or more Source: CFA Institute report, Manager Selection by Scott D. Stewart, CFA. Dec

30 In Closing Understand how we make decisions and which system we use Be aware of specific biases and use tools/tactics to help counter them Think long term Seek additional resources if needed

31 VALUE SPECIALISTS SINCE 1974 CALL BRANDES NOW BRANDES.COM El Camino Real Suite 600 P.O. Box San Diego, CA

32 Disclosures Robert Maynard is a member of the Brandes Institute Advisory Board. The S&P 500 Index with gross dividends measures equity performance of 500 leading companies in industries of the U.S. economy. The information provided in this material should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. Portfolio holdings and allocations are subject to change at any time and should not be considered a recommendation to buy or sell particular securities. Strategies discussed herein are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changes; such risks may result in greater share price volatility. Unlike bonds issued or guaranteed by the U.S. government or its agencies, stocks and other bonds are not backed by the full faith and credit of the United States. Stock and bond prices will experience market fluctuations. Please note that the value of government securities and bonds in general have an inverse relationship to interest rates. Indices are unmanaged and are not available for direct investment. The foregoing reflects the thoughts and opinions of Brandes Investment Partners exclusively and is subject to change without notice. Brandes Investment Partners is a registered trademark of Brandes Investment Partners, L.P. in the United States and Canada. Rolling periods represent a series of overlapping, smaller time periods within a single, longer-term time period. For example, over a 20-year period, there is one 20- year rolling period, eleven 10-year rolling periods, sixteen 5-year rolling periods, and so forth. The recommended reading has been prepared by independent sources which are not affiliated with Brandes Investment Partners. Any securities mentioned reflect independent analysts opinions and are not recommendations of Brandes Investment Partners. These materials are recommended for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Past performance is not a guarantee of future results. No investment strategy can assure a profit or protect against loss. Brandes Investment Partners does not guarantee that the information supplied is accurate, complete or timely, or make any warranties with regard to the results obtained from its use. Brandes Investment Partners does not guarantee the suitability or potential value of any particular investment or information source. No investment strategy can assure a profit or protect against loss. 31

33 VALUE SPECIALISTS SINCE 1974 CALL BRANDES NOW BRANDES.COM El Camino Real Suite 600 P.O. Box San Diego, CA