A De-biased Strategy for Better Returns in 2022

The average adult makes over 35,000 decisions per day.^[1] Some are big, most are small, and all require processing power. To conserve energy, we develop mental shortcuts that enable us to make snap judgements and quickly solve problems. Yet what we gain in efficiency we lose in clarity as shortcuts give way to bias.

Behavioral biases affect our thought process, sometimes leading us to make illogical, irrational or emotional decisions. Nowhere is that more evident than investment, where the complexity of markets and overwhelming amount of data lead us to rely on shortcuts that become the bane of many investment decisions.

In this interview, Steve Brice, Chief Investment Officer at Standard Chartered Bank, talks about how his team’s unique investment strategy reduces bias and yields behavioural alpha.

Q1: Investors are always hunting for alpha. Some find it, few hold on to it. What are the main sources of alpha and how do they feed into your investment strategy?

Steve: We see three main sources of alpha: informational, analytical and behavioral.

Informational alpha is when you have better access to information than other players in the market. While that was common a few decades ago, widespread internet connectivity accelerated the global flow of information. In turn, informational alpha is increasingly rare. With access to the same data and information, a lot of investors focus on analytical alpha. That entails using quantitative techniques and analytical models to interpret your data more efficiently and arrive at better conclusions.

We’re focused on behavioral alpha. We recognize that everybody has behavioral biases. Hindsight bias, confirmation bias, familiarity bias—the list goes on. Our goal is to de-bias the investment process by making people less biased on an individual level and making our team less biased as a whole. We designed our investment process to do exactly that. The result is a less biased approach that benefits from the collective wisdom of a diverse group of experts.

Q2: How does you Investment Committee put that into practice when making decisions?

Steve: We have a three-step investment process. The first step provides what we refer to as an outside view, which is something rooted in historical data that we can all agree upon.

The outside view is analytical in nature. We take a pure quantitative assessment of historical performance and use that to develop smart anchors. For instance, right now we’re keeping an eye on growth and inflation. To arrive at an outside view, we analyze historical inflation data, leading indicators and more to better understand where we are in the economic cycle. Then we can say, historically, when we’re at this stage of the cycle, this is how asset classes performed in the ensuing 12 months.

The point is this: We all have an anchoring of expectations. When we walk into the Investment Committee, we have a perception of how things are going to play out over the next 12 months. Realistically, nobody knows what is going to happen. History doesn’t repeat, it rhymes. To the extent that you and rely on history, smart anchors help us to refine our probability of getting it right.

Q3: So, the outside view provides a probabilistic assessment based on smart anchors. What happens next?

Steve: The second step in our process provides an inside view. This is where we produce analysis of competing hypothesis tables—basically a list of pros and cons for any investment decision.

So, if one of the things we have to decide is whether inflation in the U.S. will be above or below consensus, we build a table that provides arguments for both sides based on a huge array of qualitative research. We pull that research from investment banks, asset managers, central banks, academia, the IMF, the World Bank and more. We scour the market to understand why some people think inflation will be stronger than expected, while others think it will be weaker than expected.

The Investment Committee gets the inside view 48 hours ahead of our meetings, giving them time to digest the information. When we meet, this helps us avoid confirmation bias. We can say, ‘I know you’re in the stronger-than-expected camp, but I’m going to force you to acknowledge the alternative view.’ Acknowledging those views ensures that everyone in our committee has a comprehensive understanding of potential market narratives before we make any investment decisions.

Q4: When the Investment Committee comes together, how do the outside view and inside views feed into the decision making process?

In short, when we come together to discuss investment decisions in the third step of the process, the inside and outside views guide the conversation. Afterwards, people are given 36 hours to vote. This provides breathing room to digest the information. It’s also a way to de-bias the process, so people don’t give into seniority bias or speaker bias. Once people vote, we measure the results on a scale of one to five to determine which assets to overweight and underweight.

We have incredibly diverse sets of information going into this process. But we also have a diverse set of people with different cultural, educational and professional experiences. All of that shines through in the vote, where the Investment Committee considers a wide range of alternative viewpoints that effectively de-bias their investment decisions.

Q5: Is there a risk that this process engineers consensus?

Steve: I’ll start with a controversial stance. Even if this did produce consensus, does that necessarily mean it’s wrong? Equities outperform bonds two-thirds of the time. So, the consensus should normally be that equities will outperform. That’s not necessarily a smart anchor, but it’s a high-level anchor, something with a probability greater than 50% relative to history. So, you can make a lot of money by aligning with consensus.

That said, we don’t feel that our process produces a consensus. We look at a huge array of information in a very structured way, which we believe helps us take a more nuanced probabilistic view of the world. This means when our diverse investment committee has a strong conviction, it is probably even stronger than the conviction of any individual as it has taken into account more frameworks and information than anybody can process individually.

Our approach allows us to scale up the ‘size of the bet’ more than most investment processes would be comfortable with. For instance, we were overweight global equities by more than 10% for most of 2021, which clearly contributed to our 3% alpha for the year, together with our consistent overweighting of the U.S. market. After the strong performance of equity markets in the last nine months of 2020, this was a pretty bold call to make.

Q6: Broadly, what are your outside and inside views on 2022?

Steve: The outside views point to a constructive environment for risk assets generally, both global equities and high yield bonds. The outside view suggests the risk of a U.S. government bond market sell-off is higher than a sustained sell-off in equities. If we look at the macro environment overall, the inside view suggests growth will slow—particularly in the second half of 2022—but remain relatively robust and above the long-term trend. Likewise, the inside view suggests inflation will gradually ease but will not come back down to Central Bank targets. Despite that, we only expect one Fed rate hike in 2022, which we believe should be supportive of risk assets.

[1] Roberts Wesleyan College

Learn more about Standard Chartered Bank’s 2022 Outlook in A Winding Road to Normality.

This article was co-created by Standard Chartered and Bloomberg Media Studios.