Looking away successfully

The word “volatility” frequently triggers negative associations in the minds of (retail) investors because it usually is uttered when volatility is high (and prices on financial markets are falling). Moreover, elevated market fluctuations are often a cause of investment mistakes. Whoever knows how volatility is calculated and understands its psychological effects can outwit it and achieve better investment results without fraying his or her nerves.


Stock prices to go

Have you already checked stock-market prices today? Don’t worry, you’re in good company. Be it while waiting at a traffic light or in a traffic jam or while queuing at a coffee machine or paying a visit to the restroom, people here and there quickly pull out their smartphones, on which the current prices of their favorite stocks are only a tap away. The constant availability of financial data gives many a person a daily dopamine rush. The rampant gamification of stock-market trading in recent years through apps like Robinhood and its ilk  additionally stimulates the urge to press the refresh button. And even those who succeed in doing a long-lasting digital detox probably nonetheless still follow the market chatter at least on traditional channels like newspapers, television, or radio. However, looking away (or plugging one’s ears) would be the better option for many investors because investors’ perceptions of volatility contribute to causing their investments to perform much worse on average than even a simple investment in an index, just like a host of other investment mistakes do.


The journey matters

Although the objective (mathematical) annualized volatility of a market price is the same regardless of whether it is based on daily, monthly, or yearly observations, the human psyche and the way one subjectively perceives volatility behave differently. The less an investor actively pays attention to phases with high daily fluctuations and/or substantial price corrections, the less volatile and thus the less risky a market seems to him or her. Just how big the difference between frequent and sparse glances at the market can be is illustrated by the extreme example from “pandemic year” 2020: Whoever buried his or her head in the sand throughout that year, ignoring the day-to-day performance of financial markets, chalked up a pleasing gain of 16.3% at the end of the year in the example of the S&P 500 index. Such an out-of-touch investor would have simply slept through the intermittent drawdown of more than 30% that surely caused more than a few market participants headaches (and prompted some to sell in a panic). Of course, putting this advice to just look away into action is easier said than done because it’s highly likely that even those who are notoriously out of touch will receive the gloomy news anyway from his or her asset manager sooner or later. That’s because asset managers are required by law to inform a client when his or her portfolio loses more than 10% of its value within a single quarter.


Stress-free from A to B | Less (observation) is more

S&P 500 index (daily, monthly, and yearly observation)

Sources: Bloomberg, Kaiser Partner Privatbank


Doing nothing helps

What should investors do to dodge such annoying letters and to block out short-term market volatility? Would it be best to move to a desert island, bury your smartphone, and send stock-trading orders only as messages in a bottle? Although that is hardly doable in actual practice, the idea is built on a sound analytical foundation – whoever looks at his or her portfolio less frequently and has fewer opportunities to trade achieves better investment results.


"It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of stock exchanges."

John Maynard Keynes (1936)

With regard to observation frequency, Peter Mallouk, in his 2023 book titled “Money, Simplified”, notes that investors who look at their portfolios once a month have an average allocation of 59% bonds and 41% stocks. In contrast, investors who survey their portfolios only once a year are positioned with a much more growth-oriented bias with an allocation of 30% bonds and 70% stocks and are thus likely to earn better returns in the long run. Ed deHaan (Stanford University) and Andrew Glover (University of Wahington), in their 2023 study titled “Trading Hours and Retail Investment Performance,” show that investors who have less of an opportunity to trade also perform better. The starting point of their investigation is the fact that the United States stretches over four time zones and that active trading on the New York Stock Exchange takes place during different phases of daily life in those four zones. For example, the NYSE’s opening bell (at 9:30 AM) and closing bell (at 4:00 PM) ring on the East Coast during most people’s productive waking hours while the average investor on the West Coast is usually still in bed when the stock exchange opens (6:30 AM) and is at lunch when the closing bell rings (1:00 PM). The authors found that investors in western time zones, for whom standard trading hours are less convenient, pay higher capital gains taxes than investors in eastern time zones do (because they earn higher capital gains). Specifically, the annual investment performance increases by 3.9 percentage points in each time zone moving westward. To reduce the impact of any influencing factors (economic, education, demographic, health status) on this statistic as much as possible, the performance differential between counties immediately adjacent to an interior time zone border was also measured. Here, too, the discrepancy was significant, with capital gains being 2.9 percentage points higher on average just west of a time zone border. DeHaan and Glover see two different causes of the substantial outperformance by “westerly” investors: they trade less frequently, and they are invested less in single stocks and are more invested in equity funds. In a nutshell, their study shows in detail that the more retail investors are exposed to the daily volatility of the stock market and the more they are able to participate in it, the worse their investment portfolios perform. Retail brokerages like Robinhood, which recently launched the Robinhood 24-Hour Market (thus enabling 120 hours of non-stop trading a week), clearly haven’t done their investors any favors by extending stock-market trading beyond the New York Stock Exchange’s floor trading hours. The more that the focus of investor’s attention gets steered to the ever shorter term, the more that investors lose sight of the fact that stocks always generate positive returns over a sufficiently long time horizon.


A matter of time (and mindset) | All volatility vanishes in the long run

Annual return on S&P 500 index

Sources: Bloomberg, Kaiser Partner Privatbank


Reporting lag – more a blessing than a curse

Since the “desert island” solution described above is probably workable only for very few, if any, of us, this raises the question of to what extent an investor can lower the actual – or at least the perceived – volatility of his or her portfolio in a different way in order to invest with less stress, fewer mistakes, and thus ultimately with more success in the final accounting. One way to reduce volatility while boosting performance at the same time is to blend in private-market assets (private equity, private credit, private real estate, infrastructure). Private-market assets often face criticism that they undergo valuation appraisals with a substantial time lag and that their valuations are artificially inflated. The latter accusation can be refuted with facts, but the criticized reporting lag really does exist. It varies between one and twelve months in the case of private equity funds (which report most frequently with a three- to four-month lag, according to the CEM benchmarking study). However, from an investor psychology perspective, the non-uniform and time-delayed valuation reporting is more a positive feature than a bug because it automatically results in an aggregation of different valuation points and smooths the performance of an investor’s diversified private-market portfolio.


No hurry | Private equity managers take their time to report

Reporting lag for private equity funds

Sources: CEM benchmarking study, Kaiser Partner Privatbank


An additional smoothing effect with private-market assets comes from the fact that experts estimate their valuations on the basis of models that tend to be inertia-prone. All in all, both factors cause the volatility of private-market assets to be much lower than the volatility on public equity markets, in terms of both felt perceptions and what an investor actually sees in his or her portfolio. Just how strongly the two factors affect the smoothing of performance and volatility can be ascertained by means of a little reverse experiment in which we apply both smoothing mechanisms to the S&P 500 index. First we calculate Wall Street analysts’ estimated fair value for the US blue-chip index using a bottom-up approach. Then we build in the reporting lag specific to the private equity asset class. This turns the original S&P 500 index with an annualized volatility of 15% into an adjusted version with a volatility of just 5%, resulting in a massive two-thirds reduction in volatility.



Turning an apple into an orange | Smoothed stock-market performance is similar to that of private equity

S&P 500 index, indexed (market price and adjusted variants)

Sources: Bloomberg, Kaiser Partner Privatbank


Conclusion: Volatility has a nasty reputation, and not without good reason. The higher the volatility perceived by an investor, the more often that investor makes mistakes and the more frequently that he or she is positioned overly defensively. Deliberately looking away would be a simple but very successful method of dealing with this problem. But since precious few people have what it takes to follow this strategy, an alternative recommendation is to blend private-market assets into a classic portfolio. Although private-market assets are just as volatile as stocks in theory, what’s relevant is the habitual pattern of smoothed performance and attenuated volatility perceived in an investor’s mind and actually visible in portfolio reports, which helps an investor to stay disciplined and to ride out tricky market phases.


Oliver Hackel, CFA Senior Investment Strategist

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