Avoid the bandwagons, warns Ashmore’s Dehn

Jan Dehn, head of Research at Ashmore warns investors of the dangers of investment bandwagons where traditional market drivers are scarce.

In recent years both markets and sections of the media have fuelled ‘bandwagons’ – where particular stories for some reason grip the market’s attention.

Bandwagons quickly become very powerful, resulting in a streamlining of thinking, an over-simplification of complexity and the erasure of nuances, in effect commoditising ideas.

They have risen to prominence out of necessity, the mother of all invention. They have become a replacement for structural changes, conventional business cycle dynamics and monetary policy changes both of which have become scarce since 2008/2009.

Bandwagons are popular both among market makers and the media, because they can be used to persuade a critical mass of investors to move, thereby engaging the enormous volumes of liquidity trapped in financial markets since the onset of QE policies.

There also appears to be a somewhat cynical exploitation of investor myopia going on: many investors are finding that their economics education and past experiences offer little guidance in today’s unprecedented macroeconomic conditions.

This makes them more inclined to believe in fairy tales. Finally, regulatory pressures have undoubtedly helped to concentrate more and more money into narrower and narrower sets of securities, especially developed country bonds and stocks.

Bandwagons drive trading volumes and market volatility unnecessarily high, increasing revenues for market makers, but offer no value for strategic investors.

They also prey on those with weaker convictions, sucking them into their vortex, while stronger, more independent investors can experience considerable challenges in sticking to their positions, even if they are right. They encourage momentum trading over value investing.

Not only is this inefficient, it is also outright dangerous and ultimately fruitless for the majority of participants who end up chasing the market and more often than not buying at the top and selling at the bottom.

By discouraging individual thinking, it can create systemic macro risks through the homogenisation of investor behaviour. Emerging Markets (EM) investors are not immune; recent Morningstar data shows that tracking errors for US-based EM local bond market managers have halved since 2009.

What adds a particular sinister twist to the commoditisation of ideas is that it has coincided with the commoditisation of trading. Long-gone are the days when markets evaluated individual investments on their merits, that is, analysed investments on a case-by-case basis to determine if the expected returns warranted the money put at risk.

Today, most investors pool enormous numbers of individual investments into convenient buckets called asset classes, where they are given weights and benchmarked in indices that are then conveniently labelled as ‘the market’.

The commoditisation of trading is risky, because investors tend to lose sight of the risks in the underlying investments. The tools used to alleviate this problem only provide a false sense of security.

Ratings agencies tend to miss big problems and act late. Classification of some securities as ‘risk free’ only ignores the problem of risk, thus increasing the unperceived risk.

Finally, the commoditisation of trading means that investors miss out on all those opportunities that are not captured in benchmark indices (this is a particularly big problem in EM, where there are major market failures in index provision).

The best way to avoid these pitfalls is to get back to the basics of investing: adopt a value investment approach, maintain a strong credit focus, think independently and follow a medium to long-term investment horizon.

A few recent groundless bandwagons
• China hard landing: Every time the economic data turns lower in China the market lurches to the conclusion that China’s economy will crash.
• Fragile Five: The tendency to confuse cyclical imbalances, such as inflation or current account deficits with intractable structural problems.
• Euro-zone breakup: A powerful theme labelled as structural that gripped the market for two years, but which ended abruptly following a simple verbal intervention by ECB President Mario Draghi.
• Abenomics: The notion that Japan can fix all its structural problems with a dose of fiscal and monetary stimulus.

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