Closing the investment gap: Stuart Vick Smith on how women got here and how to catch up.
Women and The Investment Gap: It's Time to Catch Up
As a Generation Xer, I grew up in the era of women’s lib and saw an increasing number of women enter the workforce, including my own mom. I know many women who have risen to prominence thanks to those who fought the battle before us. But the struggle for gender equality continues on many levels.
Financially, data supports that we face an uphill battle to land the best jobs and earn an equal wage. However, it’s not work or wage alone that impacts a woman’s chances at financial success. Women also face a dramatic disadvantage when it comes to investing for our long-term financial future. This battle with our finances only begins with earning a reduced wage for doing the same job. It’s made worse by the danger posed from being too careful with our money or the simple fact that women live longer than men, and therefore need more money into retirement. All of these factors contribute to the overall investment gap women must overcome to be on the same financial footing as men.
To bridge the gap, we must first understand the reasons behind it and then take intentional steps to change the direction of investing for women so they can get on the right path going forward.
How did we get here?
This investment gap is a product of both societal norms and behavioral differences between men and women. (Remember Venus vs. Mars?) The initial cause of this gap begins with compensation. As we all know, women earn 77 cents on the dollar compared to men in the United States. Because women earn less than men, they have less to save for retirement.
In addition to lower hourly earnings, women are more likely to take time off, reduce their work schedule or opt for a less demanding (and lower paying) job during child-rearing years. Therefore, the 77 cent wage gets reduced even more for many women while they raise their children—prime earning years! As these compensation differences play out over a full career, women typically put away for retirement only about two-thirds as much as their male counterparts. And, with lower earnings over the span of their career, Social Security and other benefits may also be reduced below that of the men on the same career path.
The danger of safety
The wage discrepancy is compounded by another factor that makes the investment gap wider. Women are generally more risk averse with their money, which causes them to behave differently when investing. As a group, we prefer ‘safer’ and less volatile investments. Unfortunately, reducing risk in a portfolio also reduces its expected return. And this reduced expected return over the lifetime of a portfolio can be detrimental.
Everyone understands the dangers of taking too much risk in investing – such as betting all your savings on an unknown startup – but taking too little risk can be dangerous too. Overly favoring safer investments over appreciating investments can lead to very low returns that barely beat inflation and do little to build portfolio balances for the long term. Balancing risk is challenging for all investors. It may be helpful to find a financial advisor you are comfortable with to help you determine how much risk you need in your portfolio to achieve your specific goals.
Earn less, live longer
And finally, to add insult to injury, women have a higher life expectancy than men. On average, women live five years longer than men. The money in a woman’s portfolio is not only a third less than a man’s; it also has to last five years longer.
Close the gap
Taken together, lower pay, reduced work hours, aversion to risk and a longer life expectancy severely limit the retirement income available to a woman. This reduced income will significantly impact her lifestyle throughout retirement – meaning she may need to work longer or spend significantly less in retirement than her male counterpart. Yes, women face real disadvantages related to building wealth. But they are not insurmountable. Many women can and do manage their money successfully and enjoy financial security.
The most important step for women to get on the right track financially is education. The more you know about money, the greater confidence you will have about your future, and the better equipped you will be to make financial decisions for yourself and your family. Take the time to read books, take a class or ask questions. Do not be afraid of what you do not know. Take the power to learn and put yourself in a better place.
You may not have control over the pay gap for all women in this country, but you can control your own portfolio and how it is invested. You can control whether it is aligned with your long-term goals. You can control some factors that influence your taxes. You can control your investment costs and make sure you keep more of what you make.
I encourage all women to fight the gap, early and always. Just like saving, the sooner you start to address your personal investment gap, the more progress you can make toward long-term financial stability and peace of mind.
Learn more about Stuart at StuartVickSmith.com
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2017, The BAM ALLIANCE
Larry Swedroe on how a systematic approach can help mitigate the problem.
The typical hedge fund fee structure includes a management fee, calculated as a fixed percentage of a fund’s net asset value, plus an incentive fee, calculated as a percentage of its trading profits.
Some hedge funds use both hurdle rates and a high-water-mark (HWM) provision—the historical peak of the fund’s net asset value—in the calculation of incentive fees. These features are sold as a way to protect investors because the incentive fee is paid only on the portion of the gains that exceed either the hurdle rate and/or HWM.
Although hedge funds in managed futures, called commodity trading advisors (CTAs), typically don’t employ hurdle rates, they do generally still comply with the HWM provision that requires the fund manager to make up past deficits prior to earning the incentive fee.
The HWM feature is highly asymmetric and can be expressed as a long call-option position with a strike at the HWM. Therefore, hedge fund managers face a moral hazard issue because they have an incentive to increase risk when their previous performance has been disappointing.
For example, Stephen Brown, William Goetzmann and James Park, authors of the 2001 study “Careers and Survival: Competition and Risk in the Hedge Fund and CTA Industry,” found that poorly performing funds tended to increase risks due to the incentive fee and HWM provisions. This can create an unequal field in terms of incentives (agency risk), leading to the propensity to double-down on bets and take extreme risks when the incentive compensation is “out-of-the-money.”
Therefore, characteristics that appear “investor friendly” on the surface can, in fact, lead to increased risk. In addition, the HWM provision increases the likelihood of a fund terminating its existence and creating a new fund when it is “out-of-the-money” in terms of incentive compensation.
A Moral Hazard Problem
Li Cai, Chris (Cheng) Jiang and Marat Molyboga contribute to the literature on the agency risks of hedge funds with their study, “The Moral Hazard Problem in Hedge Funds: A Study of Commodity Trading Advisors,” which was published in the Winter 2017 issue of The Journal of Portfolio Management. By focusing on CTAs, the authors were able to classify the funds as discretionary or systematic (where trading is based on algorithms, not opinions), an important distinction. Their study covered the period 1994 through 2014.
They hypothesized that a manager “who systematically follows a trading methodology is more immune to the moral hazard problem than a discretionary manager who lacks the formulaic discipline of systematic trading.”
Cai, Jiang and Molyboga found that discretionary fund managers exhibit a significantly higher degree of risk-shifting than systematic fund managers. They also found that “tournament behavior is at work as evidenced by the relatively large increase in risk taking among the poorer performing funds.”
In other words, “discretionary managers who are underwater at midyear tend to increase their risk taking in the second half of the year.” Importantly, they found that “in most years, the impact on investors’ risk-adjusted performance has been negative, with investors getting exposed to greater risk without a corresponding increase in returns.” The impact of risk-shifting behavior was a 4.5% relative reduction in the Sharpe ratio.
A finding of interest was that a “subperiod analysis revealed that the difference in behavior is particularly strong during favorable market environments. By contrast, during unfavorable market environments, the difference in behavior is not significant because both types of fund managers avoid risk.”
Cai, Jiang and Molyboga explained that this is consistent with prior research that has found in negative market environments managers tend to be more concerned with career risk and thus engage in less risk-shifting. When fund mortality is high, survivorship is difficult and thus managerial career concern dominates. In contrast, when mortality is low and survivorship is easy, career concern is minimal.
The authors concluded that “fund managers care more about incentive fee income in good market environments but care more about survival in bad market environments. Thus, fund investors should be most worried about the moral hazard problem when the market environment is positive for fund managers.”
These findings have important implications for investors. Not only do features of the hurdle rate and HWM provisions—which supposedly are designed to protect investors—create an increased moral hazard environment, they have negative impacts on risk-adjusted returns, at least for discretionary fund managers. If you happen to be considering a hedge fund, or, specifically, a CTA, at the very least, you should be aware of the moral hazards—hazards that can be avoided, or at least minimized, when choosing a fund that invests systematically.
Discretionary Versus Systematic Funds
This strike against discretionary fund managers relative to systematic fund managers, in terms of the moral hazard risk, isn’t their only disadvantage. The other is that very strong evidence shows that the systematic approach to investing has delivered superior returns. Campbell Harvey, Sandy Rattray, Andrew Sinclair and Otto Van Hemert address this subject in the December 2016 paper “Man vs. Machine: Comparing Discretionary and Systematic Hedge Fund Performance.”
They analyzed and contrasted the performance of systematic hedge funds, which use rules‐based strategies involving little or no daily intervention by humans, with the performance of discretionary hedge funds, which rely on human skills to interpret new information and make the day‐to‐day investment decisions. The study covered the period 1996 through 2014 and included data on more than 9,000 macro and equity hedge funds. To adjust returns for exposure to common factors, they used stock factors (beta, size, value and momentum) and bond factors (term and credit), as well as FX carry and volatility.
Investors have a clear preference for discretionary funds, given that they make up about 70% of the hedge fund universe and control approximately 75% of the assets under management. However, the authors found no evidence to support such a preference. For equity hedge funds, they found both that, after adjusting for exposure to well‐known risk factors, risk‐adjusted performances were similar and that for discretionary funds (in aggregate), more of the average return and volatility of returns can be explained by risk factors.
In addition, when looking at what they called the “appraisal ratio” (the ratio of the average risk‐adjusted return to its volatility), the authors found that systematic funds outperformed 0.35 to 0.25. For macro funds, they found systematic funds outperformed discretionary funds both on an unadjusted and on a risk‐adjusted basis. The appraisal ratios were 0.44 for systematic funds and just 0.31 for discretionary funds. They concluded “the lack of confidence in systematic funds is not justified.”
The Advantages Of Objectivity
In their excellent book, “Quantitative Value,” Wes Gray and Tobias Carlisle provide further support for the power found in systematic, quantitative investing. They write that the objectiveness of the approach acts as a shield, protecting us against our own biases, while also acting as a sword, allowing us to exploit the cognitive biases of others.
To make this point, they presented the following example from Joel Greenblatt. Greenblatt’s firm, Gotham Capital, had compounded at a phenomenal rate of 40% annually, before fees, for the 10 years from Gotham’s formation in 1985 to its return of outside capital to investors in 1995.
In his own book, “The Little Book That Beats the Market,” Greenblatt describes an experiment he conducted in 2002. Greenblatt wanted to know if Warren Buffett’s investment strategy could be quantified. He studied Buffett’s annual shareholder letters and developed his “magic formula,” which he published. Gray and Carlisle show that study after study has found “the model is the ceiling of performance from which the expert detracts, rather than the floor to which the expert adds. Even Greenblatt has said the he cannot outperform the Magic Formula.”
We can perform another test in the ongoing battle of “machine (systematic) versus man (discretionary)” by examining the relative performances of two leading providers of passively managed funds, Dimensional Fund Advisors (DFA) and Vanguard. (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios.)
This table shows the Morningstar percentile rankings, adjusted for survivorship bias, for the 15-year period ending in 2016:
As you can see, Vanguard’s systematic approach outperformed 79% of actively managed funds and DFA’s systematic approach outperformed 90%. Given that the largest cost of active management in taxable accounts typically is taxes, these figures likely understate the advantage of systematic approaches for taxable investors.
The aforementioned evidence should lead you to conclude that, when you invest, it should be with a fund that uses a systematic approach to gaining exposure to markets, asset classes or factors.
This commentary originally appeared March 8 on ETF.com
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2017, The BAM ALLIANCE
Larry Swedroe reviews the evidence on how political biases can affect your investing.
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us.”
These words, from the opening of Charles Dickens’ “A Tale of Two Cities,” are among the most famous in all of English literature. Today they could easily apply to how investors view the outlook for the U.S. economy and our stock market.
Politics Affect Investors’ Market Perceptions
Whether you view the outlook for our economy and stock market as entering the best of times or the worst of times is highly dependent on your political perspective. Research on investor behavior has found that individuals become more optimistic and perceive the markets to be less risky and more undervalued when the party they favor is in power.
This leads them to take on more risk. They also trade less frequently, which is a good thing, because the evidence demonstrates that the more individuals trade, the worse they tend to do. But when the opposite party is in power, investors’ perceived uncertainty levels increase, and they exhibit stronger behavioral biases, leading to poor investment decisions.
You can observe just how strong the impact of these biases can be in the Spectrem Group’s December 2016 Affluent Investor and Millionaire Investor Confidence survey. Prior to the presidential election in November, survey respondents who identified as Democrats showed higher confidence than those who identified as Republicans or Independents. This completely flipped following the election, when Democrats registered a confidence reading of -10 while Republicans and Independents showed confidence readings of +9 and +15, respectively.
The February 2017 University of Michigan survey of consumer confidence provides further evidence. It showed Republican confidence sentiment at 120. This figure hadn’t topped 112 since 1952. For Democrats, the confidence reading was just 55.5, a level not seen since the last recession, when the economy was shedding 2 million jobs a month. Echoing Dickens’ now famous words, Republicans apparently think it’s the best economy in the postwar era, while Democrats seem to think it’s the worst since the financial crisis.
Here’s one more example. Before the 2000 election results were announced, Democrats were slightly more optimistic than Republicans. However, after the announcement of George W. Bush’s win, that changed dramatically. Roughly 62% of Democrats were optimistic about the stock market before the election, but that figure fell to just 36% in early 2001. The optimism about the overall economy was similarly affected.
The Problem Of Political Bias
Political biases create problems for investors, causing them to stray from even well-thought-out financial plans. Imagine the nervous investor who sold equities based on his views of a Trump presidency. While those who stayed disciplined have benefited from the rally, those who panicked and sold not only missed the bull market, they now face the incredibly difficult task of figuring out when it will once again be safe to invest.
It may also be worth noting that Warren Buffett’s Berkshire Hathaway has been persistently buying since the election, despite his having supported Hillary Clinton. Buffett doesn’t let his biases impact his investment decisions, which should be a clue as to whether you should allow your biases to do so.
I know of many investors with Republican/conservative leanings who were underinvested after President Obama was elected. Now it is investors with Democrat/liberal leanings who must face their fears.
It’s important to understand that, if you sell, unfortunately, there’s never a green flag that will tell you when it is safe to get back in. Never. Thus, the strategy most likely to allow you to achieve your goals is to have a plan that anticipates that there will be problems, and to not take more risk than you have the ability, willingness and need to take. Lastly, don’t pay attention to the news if doing so will cause your political beliefs to influence your investment decisions.
Summary
There’s strong evidence that the political climate impacts investors’ views of the economy and the stock market, and that it affects their investment behavior. Specifically, individual investors’ returns improve when the political regime favors their political party, and vice versa.
This result is due to two factors. When their party is in favor, investors tend to increase their exposure to systematic risk and, thus, earn higher returns. They also tend to use more passive strategies, reducing costs.
Unfortunately, investors often make mistakes with their money because they aren’t aware of how decisions can be influenced by their beliefs and biases. The first step to eliminating—or at least minimizing—mistakes is to become cognizant of how our financial decisions are affected by our views, and then how those views can influence outcomes. Being aware of your biases and acting accordingly can help you make better investment decisions.
The bottom line is that, just as you shouldn’t let the latest economic news cause you to abandon a well-developed financial plan and shift your asset allocation, you shouldn’t let the political climate do so either. As the “Oracle of Omaha” Warren Buffett stated in Berkshire Hathaway’s 1996 annual report, “Inactivity strikes us as intelligent behavior.”
This commentary originally appeared March 13 on ETF.com
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2017, The BAM ALLIANCE