In a recent analysis, investment professionals discussed the challenges of managing portfolios amidst market volatility. They emphasized the importance of adhering to a proven investment process to navigate these turbulent times effectively.
The team highlighted the concept of loss aversion, which is easy to understand but difficult to overcome in portfolio management. "Although loss aversion is an easy concept to grasp, it is much harder to overcome in portfolio management, which is why a clearly defined, proven investment process is invaluable."
This year has been particularly eventful for the markets. Many clients have questioned how their investments were managed following significant market events such as the post-Liberation Day sell-off. The response was that their approach balanced between active trading and maintaining long-term strategies.
To support decision-making during volatile periods, the team employed a portfolio exercise aimed at reducing behavioral biases like loss aversion while assessing individual securities' reward-to-risk potential. The team noted that investors are often influenced by emotional biases, which can affect decision-making negatively.
A study published in Psychological Science was cited to illustrate this point. It found that individuals with brain impairments affecting emotional control made better investment decisions than those without such impairments. This finding underscores how emotions can lead to suboptimal choices under uncertainty.
"Although loss aversion is an easy concept to grasp, it is much harder to overcome in portfolio management," reiterated the team. Their strategy involves investing in companies with high free-cash-flow profiles, low leverage, and solid returns on invested capital—attributes associated with higher returns over time.
The team's exercise involved evaluating companies based on recent market volatility and separating them into groups according to their trading positions relative to analysts' projections. Analysts were tasked with reassessing company positions based on whether they were near bear or bull cases and making informed decisions about trimming or adding positions accordingly.
Ultimately, the team believes that sticking with their established process during volatile times ensures capital allocation towards companies with favorable reward-to-risk potential.