Household Finance and Private Retirement Provision: A Marketing Finance perspective Piet Eichholtz Maastricht University
Jan 04, 2016
Household Finance and Private Retirement Provision:
A Marketing Finance perspective
Piet Eichholtz
Maastricht University
Marketing-Finance in Maastricht The Finance perspective
Start in 2007, anchored on Joost Pennings Unique International MSc program: Marketing-Finance Interface
Very close link to financial industry Alex chair and database Fortis chair Loyalis, SNS Reaal, …
Good fit with earlier research lines in Finance Department Mutual funds Pension research
Very good fit with existing research in private retirement provision Individual investor behavior and attitudes Product development
Alex platform provides unique perspective on private investment decisions
Option Trading and Individual Investor Performance Rob Bauer, Mathijs Cosemans, Piet Eichholtz (2008)
Paper uses trading data set Individual accounts between 2000-1 and 2006-3 41,880 equity traders and 26,666 option traders 8 million trades, almost half in equities
Measure impact of trading on investor performance Do investors understand risk/return? Do investors have behavioral biases influencing performance? Do they diversify adequately? How and why do they use derivatives? …
Related literature regarding private investor behavior and performance
Puzzling finding of prior research is excessive trading by private investors Barber and Odean (2000): gains from trading insufficient to cover
costs Odean (1998): investors trade too much due to overconfidence
Investor irrationality in option markets Poteshman and Serbin (2003): early exercise of options Lakonishok et al. (2007): large fraction of option activity
motivated by speculation
Strong evidence of performance persistence Coval et al. (2005): small group of investors consistently beats
markets
Average Investor PerformanceRaw monthly returns and alphas
Performance attribution using extension of Carhart (1997) four-factor model
Option-based factors added to capture nonlineair payoffs IT factor added to capture tech-related style tilts
Investor sentiment and market timingInvestors keep speculating on further market fall after recovery
Motivations for trading options (1)Type of position: put/call, own/write, covered/naked
Motivations for trading options (2)Selected results from online client survey
4,516 responses 2,323 option traders; 2,193 equity traders
Results suggest overconfidence for option traders speculation and entertainment more important for option traders
Option
traders Equity traders
Experience “I consider myself a novice investor” 18.2% 50.7% “I already invest for x years” 4.0 3.5
Investment attitude “Investment is just a hobby for me” 55.7% 43.6% “My main objective is short-term speculation” 17.2% 9.4%
Performance Persistence (1)
Existing evidence Coval et al. (2005): persistent winners outperform losers by 8%
per year, unexplained by size, value, momentum Brown and Goetzmann (1995), Carhart (1997): mixed evidence of
performance persistence by mutual funds
Why would individuals be able to beat the market? Price impact of trades is smaller Fewer asset allocation constraints
Approach Sort investors into decile portfolios based on return during
formation period, calculate decile returns in evaluation period T-test on performance difference between deciles 1 and 10 Spearman rank correlation formation and evaluation periods
Performance Persistence (2)Against hypothetical index fund and mutual fund
Performance Persistence (3)Decile performances and rank ordering
Performance Persistence (4)Investor characteristics
Conclusions
Individual investors incur large losses on option and equity investments
Poor performance explained by bad market timing due to overreaction to past market movements
Trading costs and lack of knowledge contribute to losses Gambling and entertainment seems motivation for trading Bad performers stay bad; good performers stay good
Trading hurts investor performance and trading options hurts most
Implications for private retirement provision
Left to their own devices, only a minority of citizens seem to be able to invest adequately for retirement
Some form of paternalism seems in place
The active mutual fund market does not provide a good answer Bloated costs, too much trading, weak performance David Swensen (2005): “Overwhelmingly, mutual funds extract
enormous sums from investors in exchange for providing a shocking disservice.”
Mutual funds face a fundamental conflict of interest
The collective pension system has a better cost basis … Bauer and Frehen (2008)
… but does it provide enough flexibility and choice?
Two ways outI. Steering people towards passive strategies
Overwhelming academic evidence points to passive low-fee strategies Exchange traded funds Index funds
How do we get people into long term passive index funds? The Swedish model (using a default fund) is a way out, but … … does it steer people hard enough?
Many Swedes still chose top historical performer (high risk tech fund) Only 4.1% of chosen funds were indexed Very large home bias
… is the default choice the best choice for all? What strategic mix of passive funds is optimal?
Two ways outII. Life cycle and complementary portfolios
Optimal portfolio changes with people’s life cycle and human capital Willingness to run risk Ability to make up for losses on the way
Optimal portfolio depends on non-financial portfolio Position in housing market Position in mortgage market
Design life cycle portfolios Design complementary portfolios
Portfolio based on ALM at the client level
Adjust defaults accordingly and dynamically