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Markets keep rising, but global economic problems remain. Is a "reset" for markets overdue? In this year's outlook, we explore the interaction between the world's economic problems, policymakers' potential solutions, and the global financial markets. We consider the key questions driving markets in 2017, and outline our top investment ideas in a challenging world.

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The three P’s

Deeper dive

The three P’s

Our aim in the Chief Investment Office is to provide advice that is relevant to clients and customized to their needs and preferences. To achieve this we need to look holistically at clients’ assets and liabilities (or take a “Total Wealth” view). Incorporating behavioral finance insights is the first step in this approach. It helps us focus on the three P’s – preferences, personality, and portfolios.

By accounting for our clients’ preferences, we can try to ensure that they remain in their comfort zone, even when the economic and market environments turn negative and uncertainty rises. This is important because investors who stay in the markets for the long term typically benefit from the continuous effect of compounded returns.

How would the CIO suggest we map clients to the “right” risk level? We look at three different client characteristics:

  • Risk capacity – determined by financial situation
  • Need for risk – driven by clients’ return objectives
  • Risk tolerance – driven by clients’ personality and attitudes as investors

Each client has a unique financial personality defined by their preferences. The latest research in behavioral finance (and in particular “prospect theory”) has identified certain preferences that contribute to an individual’s risk tolerance when investing. We capture these preferences by assessing a client’s financial personality. And this financial personality is dependent on three key aversions:

  • to loss: investors react more negatively when experiencing losses than they do positively when achieving gains.
  • to uncertainty: investors prefer investing with certainty over uncertainty of outcome.
  • to significant losses: also known as investment temperament.

CIO has built a financial personality module to help map investors to an appropriate asset allocation given their risk tolerance. Each client’s preferences can be identified through the use of a short qualitative questionnaire, which can be turned into a quantitative equation. Solving this unique equation for the client can help to identify an appropriate portfolio asset allocation. Investors who are more risk-averse will tend to find that they stay in their “comfort zone” by being invested in a conservative, fixed income-oriented strategic asset allocation (SAA). Investors with a higher loss tolerance are likelier to find a riskier, more equity-focused SAA appropriate.

Mark Haefele

Global Chief Investment Officer
Wealth Management

Marianna Mamou

Global Investment Office
GAA Fixed Income Strategies

Hannes Huett

Global Investment Office
GAA Quantitative Strategist

Bottom line

CIO believes that client investment needs are best met through a holistic, Total Wealth approach. Building portfolios should integrate insights on client preferences toward risk tolerance. 

CIO has developed the methodology for a tool that incorporates behavioral finance to help match investors’ unique preferences to a long-term asset allocation.

Research highlights

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