#16 Dr. Greg Davies – Transcript

SUMMARY KEYWORDS

clients, advisor, risk, portfolio, people, behavioral finance, markets, greg, year, investment, equity allocation, decision, financial, noise, oxford, goals, world, communicate, money, economics

SPEAKERS

Dr. Greg Davies, Louis van der Merwe

Louis van der Merwe 

Welcome to another episode of financial planners, South Africa. Today I have Dr. Greg Davies, who is the head of behavioral science at Oxford risk. Join me. Greg holds a PhD in behavioral design theory from Cambridge, and originates from Johannesburg. Welcome, Greg.

Dr. Greg Davies 

Hi, how are you?

Louis van der Merwe 

Great. Thank you. It’s wonderful to have you here on the show today, to unpack some of the content that you’ve produced for South African firms, it’s brilliant to see that they’re reaching out to the best of the best. But before we get into that, Greg, can you give us a little bit of a background of, of where you started how you got into Behavioral Finance?

Dr. Greg Davies 

Yeah, sure. So I started life as an economist, my undergraduate degree was actually not far from you in Cape Town UCT. I came over to the UK, I did my masters in economics, I didn’t really know what I wanted to be when I grew up. So I became a management consultant for a while, and ended up in that capacity, working a lot on sort of geeky quantum risk models for financial services. And I did that for a number of years, and had this situation where I’d been reading around the stuff that I did in my master’s, and I stumbled across this field of behavioral finance and behavioral economics. And it seemed just such a wonderful confluence of theory and practice, and of economics and, and maths and philosophy, and all these interesting things woven into it. And I decided then that I would go back to university and do my PhD. And focusing specifically in on behavioral finance, which was interesting, because at the time, we’re talking now, 99 2000, there really wasn’t anywhere you could do a specific degree or a specific PhD in behavioral finance. So I sort of ended up cobbling together my own degree, I had one supervisor in economics faculty, who was a financial mathematician, another supervisor in a psychology faculty who specialized in sort of decision making in terms of risk. And then, you know, put these things together very much was considered to be the lunatic fringe of the economics faculty at the time, I spent an awful lot of my time, sitting in economics conferences, translating psychology to them, and sitting in psychology conferences, translating economics to them. And all of them, all of them thought I was hopelessly on the fringe, which, in retrospect, I think was a good thing. Because this field of behavioral economics of behavioral finance, it really is inherently multi disciplinary, you can’t think about it just through the lens of economics, just through the lens of psychology. And I said, I did that for a while, spent a little bit of time in academia thereafter. And after I’d done with that, I got a call from Barclays, who this was in 2005, they had decided that they wanted to set up a behavioral finance team, if I’m honest, I don’t think anyone really knew what setting up a behavioral finance team meant, because no one had ever done that inside a bank in the world. But I don’t know someone had read half of a Malcolm Gladwell book and, you know, thought this, this sounds like a really good idea. And this was pre financial crisis, where banks still had, you know, lots of money flow flowing around. So they were looking for someone who had a combination of previous commercial experience plus a PhD in this fairly narrow, esoteric niche, which at that time in the UK more, you know, the overlapping Venn diagram, circles more or less came down to me. So I was just very lucky to be in the right place at the right time, and ended up starting with Barclays, what was the world’s first dedicated team of behavioral finance specialists inside a bank in the world, and then led that team for the next 10 years together with the quantitative so right from the outset? In a very practical, very applied, you know, my PhD was in the theory of how people make decisions under risk. But all of the rest of it has been, what can we do with that in the commercial world, in industry in order to help people make better decisions? Yeah,

Louis van der Merwe 

wonderful. It’s great to hear that overlap of both the human side, but also the theoretical and economic side, you know, because you can’t look at one of them in isolation, they tend to all impact how we make decisions, and that Barclays was that predominantly on the banking side kind of trying to get to nudge people into making better decisions with with the normal banking side, or was it more on the investment piece,

Dr. Greg Davies 

and it was more Well, it was within the wealth management and financial advice side. So right from the outset, it was focused on individual consumers and investors but wealthier ones. And that kind of made sense. I think, from a bank at the time, if you’re going to hire this bunch of esoteric academic sorts, to understand individual clients better, you’re going to start them on the clients that matter most which are the ones who bring in the most money, the wealthiest ones. The other, the other thing I suppose they could have done was to start on themselves. So applying behavioral finance to your own portfolio managers, your own investment managers. But in this sense, we were very much focused on on the end client on understanding the end client. In retrospect, actually, I mean, these days, I think the bigger prize is in the retail banking sphere. Because once we start to marry behavioral finance, with data analytics with digital and technology, to try and deliver these ideas at scale to the mass market across, not just investing activities, but all financial well being so investing savings, debt management insurance, it’s these tools that can help people navigate the complexity of their financial situation, at scale, that’s where I think the biggest prize is now. But back in those days, we had the advantage of using wealthy people kind of as guinea pigs. And it was an advantage because in the high net worth in the in the private banking space, you get to spend a lot of time with individual clients, you get to deploy tools on them individually, you get to understand them deeply. And very often, their financial circumstances are quite complex. So once you’ve designed a set of solutions for that world, it actually becomes much easier to go. Alright, now how do we strip that away and make it more usable for the mass affluent market or for the retail banking market,

Louis van der Merwe 

you’re kind of breaking it down and then distributing on mass. And also, I guess your sample size is just that much bigger. So you kind of get get a try to be making an impact a lot more times.

Dr. Greg Davies 

You also I mean, wealth management, you get to meet individual clients. And you know, what a lot of what we do at Oxford risk is we build tools, we build these scalable ways of delivering algorithms and tools that profile clients that match them to investments that guide people through the investment journey. It’s difficult to know how to build those, right, unless you’ve actually spent a lot of time personally, with clients understanding their their decision making, there’s a certain amount you can get from the academic literature, there’s a certain amount you can get from quantitative data. But the value of actually having having sat in many, many client meetings, and watched people are it’s it’s funny when I can watch myself doing this, but we all do it, you can watch people know what the right thing to do is, and not do it. Because there’s a big difference between the right thing to do for your long term financial needs, and the emotionally comfortable thing to do right now. And that is the essential gap that applied behavioral finance needs to solve. How do I make people more comfortable with doing something that’s closer to the right thing, not giving them the perfect thing doesn’t have to be perfect, it just has to be close to the right thing. But in crucially, I have to make uncomfortable with it. And if we can narrow that gap, we can help people save better invest better manage their debt better, all of those things.

Louis van der Merwe 

So Greg, is that reducing the gap in the trade offs between the different options? What do you mean by trade offs? So when you’re looking at and multiple decisions that someone has to make, you know, what you’re saying is that we know what the right decision is yet, it’s uncomfortable. So we make a we make a different decision, right? The list of your own one?

Dr. Greg Davies 

Yeah, I think the trade off here is not between necessarily between different financial options, or different product options. It’s between something that is financially, right, and something that’s emotionally comfortable, which could be financially completely wrong. And very often, it’s no option at all. So one case in point here is probably the biggest behavioral cost over periods of time for most investors is not what they do when they invest, it’s the fact that they invest too little of their cash. So they sit year after year after year with money that they don’t need in the short to medium term, and then leave it on the side. And the drag of that on your long term portfolio performance is can be extremely large, and it’s certainly extremely reliable. So let’s just say if you’ve only put 50% of your wealth to work, and you get average returns above what you’re getting a bank account for that amount, for a balanced moderate risk portfolio, you get maybe four and a half 5% per year. Now, the 50% you’ve left in cash, you are giving up 5% per year compounded over 510 15 years, just for the just because it makes you emotionally comfortable, or just because it’s uncomfortable, taking money from somewhere that feels safe in the short term and putting it somewhere that feels risky. So the gap we’re trying to narrow is very often, here’s this thing that might be completely wrong for my long term needs. But it’s just what feels comfortable for me now. And if we can get people over that gap, then it’s not just about deploying cash. You know, we know that people under insure on big things they over insure on Small things, they fail to save enough they fail to invest what they’ve saved. All of these things, essentially is, in the moment, doing the right thing feels uncomfortable. Because I don’t, it’s complex, or because it’s emotionally daunting, or because I’ve just got other better things to do with my life today. And so we put off decisions year after year, and they add up, they add up to an awful lot of money. And so if we can just help to narrow this gap between, or just make the things that are right, feel a bit more emotionally comfortable to people, then we’re going to, we’re going to dramatically improve their financial wellbeing.

Louis van der Merwe 

So Greg, if we add an advisor to the mix of someone wanting to make this decision yet saying emotionally, it doesn’t feel right to me? How does a financial advisor bring in that balance between, you know, confirming that yes, this does feel emotionally difficult yet helping them to make the right decision for them?

Dr. Greg Davies 

Well, I’d argue, actually, that one of the greatest benefits of a financial advisor for clients is to narrow their gap, merely having an advisor, merely having that someone there who knows more about it than you do, who is pointing at the right decision and saying with confidence, this is where you need to go, and helping you to make that decision that in itself, for many people can be worth the cost of a financial advisor. I mean, clearly, there are other benefits of a financial advisor, figuring out what is the right thing to do is itself a complex thing. So it’s financial advisors can narrow that complexity down. But the emotional comfort that you gain from an advisor to help you push the start button on your investments, to help you over time, narrow the gap between your perfect investment state and where you are right now. Because, you know, we shouldn’t think we shouldn’t expect investors to go from completely uninvested to completely perfect portfolio all at once. And it’s that journey chipping away at the right answer. That’s the value of the advisor. and the value of the advisor is helping to deliver the emotional comfort over the journey so that the client sticks with those investments and doesn’t start selling it all to gamble on a leveraged inverse Bitcoin ETF or something.

Louis van der Merwe 

Yeah, those things that we see pop up. So often I love this concept of kind of narrowing that gap. And and not just wanting to implement everything at one saying it’s this is a slow process, practically what are what are the tools that financial planners can use? You know, I know, some guys prefer phasing into the markets from cash, is it? Is it taking those type of solutions and bringing those to clients? Or what does that look like?

Dr. Greg Davies 

That’s a pretty good example. But the the tools that you would use need to be fitted to the client. And you know, one of the things that we do at Oxford risk is we have a financial personality assessment, we can measure reliably and stabilize the financial personality of an individual on up to 15 different dimensions. Now, there are certain individuals, let’s just imagine my my key job right now is to persuade you to you’re sitting 100% in cash, you find it uncomfortable to move that money from the savings accounts to the investment account. And so I want to know which of these techniques do I use for you, there are some people for whom phased investment is a is a good thing to do. Now, interestingly, classical finance theory tells us, it’s the wrong thing to do, right. So phase, if you’ve got a pot of money that is sitting, if any of it in cash is just dragging down your returns your expected returns over time. And that’s true, technically and financially and mathematically, it is the wrong thing to do. But relative to doing nothing at all, it’s actually a pretty good option. So rather than agonize about getting people to do the perfect thing, right from the start, actually introducing a little bit of the wrong thing, which has a very minimal cost, as long as you’re using it as a mechanism to gradually bring people towards the right thing is really good. We can think about it as people will not do the right thing. Unless they have enough emotional comfort to do the right thing. To get emotional comfort costs you something you can’t you’ve got to you’ve got to find it somewhere, right? It just doesn’t doesn’t come out of nowhere. Now, one of the places it comes from is your nice cheerful advisor who’s who’s helping you and you pay for the advisor. And so you’re paying for your emotional comfort, giving up a little bit of returns in order to phase money in gradually, you can think of as buying emotional comfort. It’s It’s It’s, you know, relative to Spock, doing the perfect thing right from the outset, it costs you a little bit of money, but relative to you losing 5% for the next 20 years. Actually phased investment is a very good thing. There are many, many techniques like that, which ones we choose there really need to be suited to the individual financial personnel. Have that client. And just you know one example, one of the most important scales we measure, aside from risk tolerance, which of course, is a vital component of any financial advice and suitability system, by the way, often measured extremely badly. But let’s leave that aside for now. The probably the next most important scale is composure. And you can think of risk tolerance as being your long term, cool, calm and collected willingness to trade off risk and return. composure is about your short term emotional attitudes towards risk. Someone who is a high composure individual will find it easy to keep their eye on the on the distant goal, they won’t be that worried about the ups and downs, they’ll find it easier to deploy the cash. And if you tell them to phase investments very slowly over time, you’re basically just costing them money that they don’t need, because they don’t need that sort of emotional comfort bought for them. Someone who has low composure. On the other hand, for them, phasing the investment and giving up those initial returns is absolutely vital, because without doing that, they’re not going to get out of the cache in the first place.

Louis van der Merwe 

So this sounds very similar to a kind of a workout program, right? We couldn’t start with a 50 kilometer bike ride, you would slowly build up with your personal trainer to something that’s customized to your body and what you’re ready to accomplish.

Dr. Greg Davies 

Yeah, great analogy,

Louis van der Merwe 

the things that you’re talking about Greg, and I picked up on one of the reports that you did for Ned back talking about behavioral personalities and those composure zones, can you maybe give us a little bit of an insight on on how that study was conducted? And also just kind of some of the interesting findings?

Dr. Greg Davies 

Yeah, sure, sir. We have at Oxford risk, a standard set of these personality scales that we have built over the years and validated and calibrated quantitatively on 1000s of survey responses from investors all over the world. And what we did effectively for Ned bank was to take these psychometric tests to a large pool of their clients, and indeed, some of their advisors. In order to understand what are the what is the spread of personality dimensions out there? interesting for us? Are they different in South Africa, then in the UK, for example? Is the advisor population did they have particular characteristics that are different from the client population, but then just looking at investors? Really, what’s important is I want to look at each investor as an individual. So I want to understand their unique signature across these act, we didn’t use all 1515 is a lot to use, I think we actually measured 12 for Ned bank, across these 12 different things. What does that tell me about this person? And therefore, what do I do differently for this client? around? How do I construct their portfolio? How do we communicate with them? How do we report the results to them? How do we do we hold their hand more effectively in times of market volatility? So we were gathering all of this data? And then once we had that, we can also start to say, Are there particular pockets of common personality combinations that exist out there? And then you can start using that to go well? Is our proposition fit for purpose? Are there pools of personality types out there that are common, that we don’t have a proposition that’s well designed for all that, we need to think about rejigging our marketing to to more effectively suit these investor archetypes that exist from a data driven and empirically driven basis.

Louis van der Merwe 

So I like this idea of kind of grouping them together and saying, Let’s customize the way we communicate. And I know we speak about this a lot that your marketing should look like that. But for a medium or smaller sized financial planning firm, often it’s quite onerous creating multiple ways to communicate with clients. If you had to put something in place to actually communicate on board, like what would be the main groupings that you would have, essentially segment your advice client base in?

Dr. Greg Davies 

Well, we normally would do this quite individually for for each of our clients, so particularly large clients, because the people who walk in your door to take advice will depend on your brand and your marketing etc. So we can do a sort of segmentation exercise. That’s, that’s unique to each. But if you’re a smaller advisor, really, it’s about it’s about these key dimensions. Now, when I talk about these 15 dimensions, these are the data tell us that some of these are the smallest number of things you would want to know about your plants that explain the greatest amount of variability between them. So even if you just take a subset like a few of those key dimensions, and you go Let me think about how I would market to different combinations of those, then you’ve got something very powerful. So I’ll give an example. I’ve already mentioned composure, you get people who have low composure, you get people who are high composure. Another one is confidence that matters a lot in investment advice, there are clients out there who are quite confident taking investment decisions. And there are others who are very reluctant, they’re just emotionally want to avoid the decision making. Now, if I just took high and low on both of these, I’ve got a little two by two matrix. And I’ve got high composure, high confidence, low composure, you know, all the combinations of those. And there I have just four groups, each of which will have quite a lot of quite quite a chunk of clients in them, that I can then go by, by thinking about my marketing messages, if I write it in just four flavors, I’ve covered off an awful lot of what it is what it means to be different as an investor. And this can be particularly powerful in times when markets are volatile. You know, as I mentioned, this week, markets go into utter turmoil, we know that markets are going to drop, right, it’s just a question of when so since we know that markets are dropping and drop, we know that at some point in the future, we are going to have to pick up the phone and talk to our clients or we’re going to have to send them something to hold their hand and chop them off the ledge. So that stuff can be pre prepared. And when you can have this piece of information that comes out and goes, markets were incredibly volatile last week, you sent it on a Monday morning. Now, if you have that written in just these four different flavors, it means you’re talking much more effectively to your clients based on their financial personality. And so you use a profiling tool of the sort, we have to make sure you know which clients are in which cluster, when the markets are volatile, you’ve already got these pre prepared things off the shelf, you hand it to your advisors, you hand it to the clients, and it’s going to have a more direct effect on their emotional state because you’re saying the right thing for the right person. Okay, so

Louis van der Merwe 

this also helps you prioritize who you’re reaching out to. And that message, I was listening to a podcast, from the guys from betterment, who’s a US based robo advisor. And what they saw in this study was the clients that they communicated in terms of market corrections actually did worse than the clients that they just didn’t communicate to. I’m wondering what you’re kind of what your take is on that.

Dr. Greg Davies 

So the crucial thing there, and when we, you know, when we build these sorts of algorithms to do this, at scale for large organizations, is it cannot just be based on personality. things, we also want to exclude other data. So for example, I want to know, how much is your portfolio dropped. So it might be that the markets have plummeted. But actually, your portfolio, for whatever reason hasn’t been that bad, then I can start to flip the message. And I can say, given people a comforting message off, you know, don’t worry, because everyone else has lost money. But you haven’t. I also want to know, is there a signal that this person has, for example, logged into their account over the weekend to check on the value of their portfolio, because there’s nothing worse than taking a bunch of people who maybe aren’t that interested in the markets and aren’t that interested in finance. And on Monday, you send them a letter that goes, you’re probably panicking because your mark, because your portfolio has dropped 10%. And they weren’t panicking at all, they hadn’t noticed it in the slightest. And what you’ve done is you’ve just triggered this panic. And in fact, I mean, there’s a regulatory rule that was put in place across Europe, when they released the mifid two, regulation, which was the 10% drop rule. It mandated that every advisor when any ever any of their clients portfolios drop 10% or more in a quarter, they had to send them this letter that went Don’t panic. And what is particularly revealing about that is last year, when COVID hit and the markets dropped in March, one of the first things the FCA did in the UK, was they suspended the use of that rule. Now, when you’ve got a rule in place that you have to suspend the moment that rule kicks in, you probably got to think it wasn’t the widest rule to put in place in the first place.

Louis van der Merwe 

And is that this what they intended? And then they said, Okay, let’s, let’s not do that it would would have been such an interesting exercise to see what would have happened if everyone was notified and this arbitrary figure of 10%. What do you see dealing with clients is that often the ones that you look at the the investment returns only once a year, have much better financial outcomes than kind of the the higher frequency quarterly checking clients. Right? And are we not maybe doing a disservice to our clients by communicating too much in terms of the frequency and what we saying?

Dr. Greg Davies 

Yeah, I mean, there’s three things to say about that. I think most probably many things to say about that. But three that occurred to me, here is, one, you’re absolutely right, we need to be very careful about communication. But in the first place, there are things that we should be communicating about more, and there are things we should be communicating about less. And the mistake is often to go, what’s happening in the world, because that gives me the best excuse to communicate with my client. That stuff, we should be pushed into the background, right? markets go up, markets go down, nobody knows why. Right? Just don’t talk about it that that that’s not the stuff you should be communicating about. What you should be communicating with your clients about is how much surplus cash Have you gathered, that is above your spending buffer that you can deploy into the market? Have you thought about how your long term goals are changing, as your circumstances have changed, post COVID, etc. So we should be engaging with and communicating with clients much more around the review of how our portfolio is set up. And rebalancing at a quarterly or six monthly or whatever, whatever it is basis around people’s goals and aspirations to talk to them about the big picture, where they’re headed, what they’ve got now, which gaps still need to be closed, do not talk to them about this, you know, constant, what’s happening in the markets outside there, because they can’t do anything about it. Or they can do things about it. But those things are mostly costly, they can trade too much they can even just watching it induces emotional anxiety, which leads to subsequent bad decisions. And then and then costs. The third thing to say is when you are communicating if you have to communicate about the markets, and of course, we have to report performance periodically. It matters an awful lot, how you present those data. So you can imagine two clients, let’s imagine they have exactly the same financial stock, let’s just imagine that one person, right, but in situation a this person has gone to advisor a and advisor a says, okay, we put you you’re in this portfolio, my job is to keep you maximally informed about how your portfolio is doing. So what I’m doing every week, I’m going to send you a sheet and it’s going to on the front page, it’s going to have how every one of the 50 sub items in your portfolio has done since since last week. Now, I guarantee you that every week, something will be flashing red. And because we as humans are heavily focused on losses, you know, the whole loss aversion loop, they loom larger than gains, the red stuff will loom much larger than it should in our decision making it will induce anxiety, etc. hypothetical situation be the client has a different advisor, same portfolio, same 50 items that the advisor said it’s not my job to inform you about minute by minute market moves, my job is to get you good long return returns. And what I will do is every six months, you will get a report from me. And on the front page, you will see none of those 50 items. And you will see nothing in a weekly time horizon, what you will see as the rolling performance of your portfolio over the last three or five years. And I’m not going to hide anything from you, if you want to, you can drill down and see how all of those things are doing over various time horizons. but merely by having a front page that is high level and long term, you completely change the emotional response to the same portfolio. And that becomes really important. So yeah, talk to clients much less about markets and portfolio performance, talk to them much more about where they’re going and their structure of their wealth. And when you do talk to them about market performance. Stay away from the details. Make sure that you control the narrative

Louis van der Merwe 

and love that piece of bringing it back to their kind of locus of control. The things that you can control, actually is where your financial planning can come in and then say, Okay, well, what, what are we going to do with this new information? Or is it just information for the sake of knowing? Yeah,

Dr. Greg Davies 

absolutely.

Louis van der Merwe 

Greg, I want to jump into some of the research that you’ve done for momentum around the noise and investment advice. And you know, it, it kind of came out a little bit before kind of man’s new book of the, you know, 10 years in publishing another, I would say bestseller in the making. Yeah. How did how did this come about? And what was the brief that that you received from ventum?

Dr. Greg Davies 

I will say first that although we published the report slightly before the book, noise came out, we started working on this noise idea before we knew there was going to be a book, which still came from economists. He wrote, he co authored an article in the Harvard Business Review in 2016. Around this concept of noise, and we thought that was great, and we thought nobody really understands how much noise is or isn’t an issue in the investment advice industry. So we have been working on this idea of measuring noise and actually we went to momentum with it and said what went to many people with it, but If momentum was the one with the foresight and the precedents to, to pick up on it, the whole idea here is an annual, I’ll start with something not about investment advice. But imagine, you have something wrong with you, and you go to the doctor, and you want that doctor, to be accurately diagnosing What’s wrong with you, and fairly any, and you want the doctor to be giving you a prescription that is appropriate to your situation, your diagnosis, your needs, etc. What you don’t want is for it to be a lottery, such that whichever doctor you happen to see, one of them sends you under the knife for an operation, the other one puts you on a lifetime cost of pills, the other one tells you there’s no issue at all, don’t worry, and the other one tells you just to eat less and sleep more, right? Because you’ve got the same issue, regardless of which doctor you go to. And you want to have a diagnosis that is accurate. And that is going to give you the best outcome. But what we see again, and again, we see this in medicine, this is part of the book, you know, they have these illustrations from medicine, from, from the legal world, from people coming up for crimes, you know, for exactly the same crime, the sentence can be everywhere from 12 months to 20 years. And a lot of their their evidence here is from the US. But I think the same is true everywhere in the world. And this is noise, it’s when a given decision depends on the lottery of the decision maker that you get. And it depends also on the lottery of perhaps when this decision maker gets it. So if a given judge tends to be very lenient on nice sunny days, but tends to be very stringent if you come on a rainy day. That’s noise. And what it is, is its variability and subjectivity in the decision making process. That means the person for whom this decision is important to the person being tried the person getting financial advice, the person getting medical advice, has no idea really of whether the advice is good or bad, because it’s complete lottery as to who they see. So what we did for momentum, and actually, this was in conjunction with the South African financial planning institution as well. We went to several 100 advisors, and we gave them case studies of six different clients. Now, this was simplified. And we need to be careful here, because these are hypothetical situations. And you know, the information is limited, and what we simply asked each of these advisors, now that you have a lot of information about the client’s age, retirement date, size of their investment account, future goals, you know, that the stuff that should come into answering the question, what is the right risk level for this client to have? We then asked each of these advisors, what do you think the right risk level is? What do you think the equity alik? Right, equity allocation is, etc? To see if the same client goes to 200 advisors? Do they get? Do they get an answer that’s right for them? Or do they get 200? different answers? And the answer to that is sad to say, but unexpected is you get 200 different answers. Before every one of those six client vignettes we put in front of advisors, the recommended equity allocation range between 0% and 100%, for the same set of clients circumstances. Now, we don’t necessarily know what the right answer is. and reasonable advisors might disagree on what that right answer is because figuring out the right amount of you know, the right asset allocation for someone involves lots of different moving parts. And some people have investment philosophies that are more like this, they’re more likely other. But none of that really matters to the end client. Because what they want to know is, is it roughly right for me? And even if we don’t know exactly what the right answer is, we know that it’s not a full range from 0% to 100%. And that sort of noise is a cost on the on the financial services industry. It’s a cost on the clients who are getting the advice, and it has potential regulatory and compliance implications. And what we did for momentum is we started to say, let’s dig into the data, can we identify where this noise is coming from, and then can we most crucially, helps you to make it better. So this was really done this, this is not, you know, a go in and wag our finger at at advisors, because some of you know a lot of this is about a training exercise. All the advisors who do you went through it with CPD accredited, they got individual reports back on how they differed from the average advisory group. And I think these sort of tools and techniques, greater awareness, that noise is an issue, great training to make sure that different pieces of the puzzle are put together consistently. So are you giving risk tolerance, the same weight as another advisor? And then ultimately, you know, this comes down to really what we do at Oxford risk is figuring out the right piece of advice is complicated. It has a lot Lots of moving parts, and we have to bring them all together and weigh them. The use of technology to solve this problem to go, give me all the 50 things I need to know about this client, we will make sure that the algorithm packages them together and weighs them in a way that is absolutely consistent from one client to another, and spits out the right answer a bit like a doctor would use an X ray to get that diagnosis. This can make advisors more consistent. But even more is it frees up advisor time because they don’t have to spend their time juggling all the numbers, what they do is they get an output that they can spend their time doing the stuff that humans are good at and that humans are valuable at which is delivering the delivering the answer delivering the emotional comfort persuading clients the best route to get to that answer. So you don’t want basically the answer here is you don’t want too much human in your diagnosis process. You want the human in the prescription process to figure out what the best course of action is, once you’ve got a diagnosis.

Louis van der Merwe 

Yeah, that’s such a nice summary. Greg, what struck me was specifically once an advisor managed to decide that this client falls into this risk category in that first couple of risk categories. Equity allocation, like you mentioned, it is massive, it ranges from from zero to 65%. In the least risky category, actually, there has to be some kind of best practice standards for us to say 65% equity is not okay. And where do we start to to create best practice rules within financial planning when it comes to portfolio construction? Or do we just use the efficient market hypothesis and say, Hey, over time this as you move up the efficient frontier, your equity allocation should be more?

Dr. Greg Davies 

Yeah, I mean, this is something that, you know, I’ve been struggling with trying to try to develop the best practice for for 15 years here. And there are a few areas where across our industry, there’s a little bit more of here be dragons on the map. And arriving at the right equity allocation, the noise comes in two parts. The first part is, am I allocating the client to the right risk bucket to the right risk profile, your three or four or five, or whatever it is. And the secondary, once I’ve decided you with your 3am, I giving you the right level of risk for that three. Now, the first bit, we have tools we have there are very good risk tolerance tools out there that can go this client’s risk tolerance is a three out of five, and then we’ve got slightly the tools for this or worse, but let me now bring together all pieces of their financial circumstances and their cash flows and their balance sheet and weigh all that up and determine risk capacity, and then bring all of that together. That gives you the right risk profile for someone. And certainly that’s something that, you know, at Oxford risk is a core part of of what we build and deliver. The next bit if once I know someone’s a three, what does that mean? What what level of risk is right for someone, that’s a three. And this is an area where there is genuinely an awful lot of hand waving. And you know, you’re gonna have three, balanced, right, there could be equity allocation anywhere between 35 and 65%. And some of these risk profiling systems, you know, honestly, the bands are that bad, you bet you that are that broad, you could drive an oil tanker between them. Now, that doesn’t help the advisor, I know, my clients are three, I need to know what portfolio is right for it. What we have done any of you mentioned mentioned efficient markets, we have built a framework that goes once I can reliably place a client on the scale, we use a combination of decision theory, utility theory and modern portfolio theory. So we have a theoretical framework that we can use to calculate long term risk bands. So the outer band, what is the upper lower and the upper layer? That’s, that’s right, for a person is three for a long term portfolio. And so we have a sound methodology for doing that. But it is an area where I think almost across the industry, people are kind of making that bit up at the moment.

Louis van der Merwe 

Yeah. So would that tie into kind of how much risk would you require to meet your financial goals, you know, kind of the required risk risk capacity and in risk tolerance to build that permit?

Dr. Greg Davies 

Yeah, so risk required is a big bugbear of mine, because risk required is not required, which required is mostly harmful in a financial advice process. Now, I need to be careful when I say that, because what I’m not saying is that your future goals are unimportant, where your future goals, when and how much when you need to spend money and how much you need to spend. And your priority on that is a vital part of understanding your risk capacity. If I’ve got if I’ve just retired and I’ve got nothing but lots of future liabilities to fund that reduces my risk capacity and I need to be careful Because if I take too much risk now and the markets dropped, I have to still pull out the money I’m, you know, I’ve harmed My, my, my financial well being forevermore. So the goals really plays a role in determining risk capacity appropriately. Once I have decided, however, the right level of risk that people are willing to take, and that people are able to take, the best solution for them is to take that level of risk. Now, this is why risk required can be dangerous, if, by taking the level of risk that I am willing and able to take, I am not going to meet my goals, I should not dial up that risk, I need to want less, I need to reduce my goals and my expectations. dialing up risk, in order to meet goals that you can’t meet with your risk profile is a very bad idea, it does increase your chances of meeting the goal, it also increases your probability of catastrophic Lee failing to meet any of your future goals. So taking more risk, then your willingness and your capacity to take risk, extremely dangerous. Taking less risk is scope for a bit more disagreement there. Now you could go, Okay, I might, my tolerance and my capacity mean that I’m a risk profile four out of five. So I really don’t want very much from my life in the future, I can meet all my goals, just by taking risk level one. Now that’s I think less harmful, you can still do it. But we would still suggest your optimal thing is ignore the risk required there. You still want to take the risk level form. Why? Because your goals, change your preferences, change, circumstances are changed or changing. If I have the ability, the willingness and the capacity to take that risk, I should take the risk in order to build up my resilience against future changes in the world. So taking much less risk than you’re able to take a willing to take just because you’re not required to take it is actually in a way harmful to your ability to adapt to the world as the world changes catastrophic Lee around you, as we’ve been able to see recently. You want to you want to get as much long term returns as you can for the risk that you’re willing and able to take and I think this whole risk required notion is barking completely up the wrong tree. Yeah. And

Louis van der Merwe 

there’s so many pieces that you can bring in, because what we’re seeing now on a lot of the technology is also the probability of success, you know, how likely are you to actually get get a good outcome, and that requires these three pieces in as well. And at the end of the day, I think clients are so confused that they don’t necessarily know what’s going on, they just give up and say, Okay, I agree. And let’s, let’s stick to this portfolio.

Dr. Greg Davies 

Look, I think it’s nice to understand the probability of success in meeting your goals. And that can be quite a motivational thing. Because if I’m, if my probability is is lower than I want, well, then I know I need to save more. I know I need to if I’m not taking as much risk as my profile, I know I can, I can do better by taking a bit more risk. It’s when I start to try to increase that probability by by taking risk that I’m not able to take that you go well, okay, yes, I’m increasing the probability of achieving that goal. I’m also increasing the costs of failure, you cannot get one without the other. And we need to be very careful of that

Louis van der Merwe 

gets back back to our trade offs, from the beginning of the conversation. Greg, if you had to give a guideline to your family to appoint a financial advisor, if you’re no longer around? Or maybe you’re working with one already, what is on your list? When you pick a financial advisor? What are those non negotiables?

Dr. Greg Davies 

Oh, that’s an interesting question. I mean, apart from the the obvious ones, it needs to be someone in in your jurisdiction or has the knowledge to to cover, you know, the geographical spread of whatever your family needs? I think, well, so. So the first one is difficult to to gauge, but I think it’s very important. I want an advisor who’s prepared to say, I don’t know, because what and it’s ironic, you know, it’s one of the things that clients least want their advisor to say, I just, I don’t know what the future is, I don’t know what it holds. And yes, it’s yet it’s probably the greatest source of reliability in quality of an advisor. Because the reality is, we don’t know where markets are going, you know, in 12 months or 18 months or horrible or wherever. So, you know, the thing that people reach for, the comfort of certainty is at the same time, often an indication of what you should avoid. So that would be one. Another one is, look, I think fees are important. I want there to be one that advisor to be very transparent about what they’re charging, doesn’t necessarily mean going for the cheapest advisor, but I want to transparency and clarity and what it is, and I want I want there to be I don’t want these you know, entry and exit fees, anything that locks me into an advisor if that advisor has done a bad job is it A sign that you should avoid, avoid that advisor from the outset. So that I think is very important. And then the last one, well, let me let me do two more what I want that person to think holistically, I want them not to be advising me on this portfolio, or this investment, I want them not to be agonizing about whether I choose this share all this stock, I want them to be taking the big picture of my wealth in the long term, I want them to be looking at my financial situation, not at the minutiae of an investment investment portfolio. And the last thing is, I want them to demonstrate good process. I don’t need them to have the answers, I need them to be able to say, here are the steps that I’m going to go through. And I will go through those same steps for every one of my clients. Because only by doing that, do I know that I’m not getting a very noisy, noisy process with a lot of subjectivity in it.

Louis van der Merwe 

Love, are you into that one? I think that is a perfect way for us to in this conversation. It’s been wonderful to have you here. What’s the best way for people to get hold of you if they’d like to do so?

Dr. Greg Davies 

Yeah, our, our website is www dot Oxford risk, or one word.com. So you can look at, you know, some of our stuff there, all of our blogs are on there as well. I’m quite active on Twitter at which is at Greg B Davies, or one word, Oxford risk is also on Twitter. So that’s Oxford risk, Ltd. So all of those are feasible ways to connect with us. We produce quite a lot of content that you’ve mentioned to today the recent report with with with Ned bank and and with momentum, but we do serve clients all around the world. And we’re doing a lot of work on ESG and sustainable investing around the world. So we’ll get a report shortly to come out about that. So there’s a lot there’s lots of stuff coming out. So those are good ways to follow us. If you go to the website, you will also be able to fill in a form to sign up for the newsletter if that’s of interest to anyone. Brilliant.

Louis van der Merwe 

Thank you so much, Greg.

Dr. Greg Davies 

Absolute pleasure.