Choosing a unit trust could be a Squid Game

By Paul Nixon, Head of Behavioural Finance at Momentum Investments

Paul Nixon

Most of us like to think that any choice we make (particularly the big ones) are carefully considered and not influenced by external factors. As it turns out, this couldn’t be further from the truth.

The ‘default effect‘, for example, shows that in European countries where the default is for people to opt-in to register as an organ donor there is a low participation rate (between 4.25% and 27.5%). In countries where people have to opt-out to de-register as an organ donor participation rates are between 85.9% and 99.98%1.

However, a survey in these countries showed that nearly 80% of people wanted to be organ donors. The choice architecture, or how the decision is presented to the decision-maker, therefore, has a significant impact on the outcome. Similar swings in preference are also clear with the ‘order effect‘, where a candidate’s order on the ballot paper can mean the difference between being elected or not.

The world of investing is no different. Financial advisers and their clients are faced with thousands of investment options daily and which often result in poor choices. We can conclude that poor choices are being made by the high levels of switching activity reflecting a regular change in preferences. The Momentum Investments Sci-Fi report for 2022 showed that over R180 million had been destroyed in value from switching money around since March 2020.

Most of us would opt for more choice, but more choice doesn’t necessarily mean better outcomes. More options don’t mean we will see or find the one best for us.

Good choice architecture is one where it is relatively easy to get to a decision that reflects our preferences. Renowned decision scientist Eric J. Johnson teaches a valuable foundation principle of getting this right. There is a constant tension between two key ingredients to a great choice architecture where the result is better choices and outcomes for decision makers. These two key principles are:

🎯 Fluency refers to the number of options and ease with which these are navigated. So, if we sell one investment fund and present this to all clients, we have hit the ‘fluency’ mark. We haven’t overwhelmed people with tons of options, but this doesn’t necessarily mean a great outcome for any one client whose circumstances and goals aren’t a good match. The choice architecture will have high fluency but very low accuracy.

🎯 Accuracy refers to the outcome. We choose something that accomplishes what we set out to do. The opt-in organ donation programme, for example, is less accurate simply because the choice architecture results in fewer people ending up becoming organ donors. The opt-out programme is more accurate because it is a better reflection of people’s preferences. The problem, however, comes in where we consider the emotional cost to the families of people donating organs (by default due to the choice architecture) that are perhaps contrary to their religious values. But that is a discussion for another day.

Source: Momentum Investments (2022)

When it comes to investments, by adding just one more fund we can double the accuracy at the cost of little fluency. This is where the ‘science’ in decision science comes in – finding the proverbial sweet spot where we get the greatest fluency and most accuracy for clients.

The current investment landscape choice architecture of over 120 boutique asset managers in South Africa alone, with more than 1 000 unit trust funds across a number of investment styles (value, growth, momentum, active, passive etc.) is one with little fluidity and accuracy. The result is one where investors and advisers alike often focus on past investment performance to make their choices – a strategy that almost guarantees failure.

Streaming giant Netflix solves a similar problem with great choice architecture. Over 6 000 titles are presented seamlessly to viewers in small clusters (fluidity) by getting to know customer preferences better (accuracy). Defaults are also used extremely effectively as hovering over a title for seconds automatically triggers a short trailer. And different trailers appear for different people, once again based on their preferences and viewing history. Netflix, however, has an algorithm. Investors need advisers to fulfil this critical role.

Outcome-based solutions have high fluidity simply because the complexity and number of options are removed from the equation, leaving advisers with a handful of options to match with a client’s personal financial goal (improving accuracy). The adviser is then left with the critical product wrapper (tax planning) part of investment planning as well as that of managing the investors’ behaviour en-route to achieving their investment goal (aligning behaviours with goals). Our outcome-based investing approach is more than an investment philosophy – it’s a belief system defining the way we manage and grow investments.

With us, investing is personal. But making investing personal is not about more choice or products. Making investing personal is about producing a choice architecture where each and every investor realises their investment dreams.

Outcome-based investing is about placing your clients’ goals at the centre of the investment process. We help construct investment portfolios or funds based on what you want to achieve, how much your client has to invest and when they need the money by. This forms a solid foundation for achieving their investment goals.

1Johnson, E.J., 2022. The Elements of Choice: Why the Way We Decide Matters. Simon and Schuster.

Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services and registered credit provider (FSP 6406).

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