How Short-Term Noise Affects Risk Taking

Fewer updates on price movements leads to riskier investments and higher returns, research shows.

Frequent updates on asset price movements could result in risk aversion—and lower returns, according to the National Bureau of Economic Research.

Investors who keep close track of price information invest in fewer risky assets and miss out on higher potential returns, found Francis Larson, co-founder of behavioral technology firm Normann, along with John List and Robert Metcalfe, researchers at the University of Chicago.

“In their normal course of business, professional traders who receive infrequent price information invest 33% more in risky assets, yielding profits that are 53% higher, compared to traders who receive frequent price information,” they wrote.

The trio studied professional foreign exchange traders between March and April 2016, analyzing over 864,000 price realizations provided through a beta test of a Normann trading program.

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The traders, who were unaware of their participation in the experiment, were given a starting cash balance of £1 million ($1.33 million) with the ability to trade a “risky” fund that tracked the relative value of the US dollar.

Half received second-by-second price information while the rest were given updates every four hours.

“While the two groups observed the same price realizations, traders in the ‘frequent’ group saw more negative draws than traders in the infrequent group,” the authors explained.

While it took a few days for traders to learn the expected value of the risky asset, by the end of the experiment the “infrequent” group had invested more in the USD fund, and in turn earned higher returns.

The results backed a prevalent theory among behavioral economists that the “equity premium puzzle”—the high real return of US equities compared to relatively riskless securities—is caused by myopia and loss aversion.

“Since our traders are vital components of the price discovery process,” the authors concluded, “their investment patterns reveal that marginal traders behave in a condition that is consistent with myopic loss aversion.”

Read the full paper, “Can Myopic Loss Aversion Explain the Equity Premium Puzzle?”

Home > News > Asset Allocation > Preqin: Private Debt Becoming ‘Fixture’ in Portfolios

Asset Allocation September 21, 2016

Preqin: Private Debt Becoming ‘Fixture’ in Portfolios

More than two-thirds of surveyed investors planned to grow their allocations to the asset class over the long term.

Investors plan to up allocations to private debt, citing high satisfaction with the asset class’ performance, according to Preqin’s latest survey.

Of more than 160 institutional investors surveyed, 67% indicated they would increase their commitments to private debt over the long term. The majority of survey respondents said they viewed the asset class positively; just 9% held a negative view.

“Having once been considered a niche part of the alternative assets market, the private debt industry is continuing to cement its position as a fixture in many investors’ portfolios,” said Ryan Flanders, head of private debt products at Preqin.

Private debt investments have largely met or exceeded investor expectations, the survey found, with 84% of investors reporting satisfaction. Over a quarter (27%) said their confidence in private debt’s ability to achieve portfolio objectives had increased over the last year.

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“The recent performance of their private debt investments has met or exceeded the expectations of most investors, and as a result, the general perception of the asset class is currently very positive,” Flanders continued.

Although the majority of respondents still invested in the asset class through their private equity allocations, the number of investors with independent private debt allocations is slowly growing. According to Preqin, 12% of investors had separate buckets for the asset class, compared to 11% six months ago.

Nearly two-fifths (38%) remained under their target allocations, and almost half (46%) planned to commit more capital to the asset class over the next year.

When making those commitments, investors said fund strategy was the most important factor to consider, followed by track record length and past performance.

Of private debt strategies, respondents favored direct lending, mezzanine, and distressed debt. They primarily targeted investments in North America and Europe.

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