The Information Risk Premium: Danger and Opportunity

Information Risk Premium

When you step back and look at the investment landscape, it is sometimes helpful to ask yourself if anything really IS different this time; to try to determine what has changed.

The usual answers point to recent return gyrations: the tech bubble’s spectacular burst ten years ago, the near-death experience of global capitalism in 2008-2009.  But the truth is, we’ve seen all this before in one form or another.  Ask your grandparents; the 1929 crash and Great Depression were far more painful to far more people than anything we’ve experienced in recent years.

What is Different?

Michael Aronstein, who manages a mutual fund called the Marketfield Fund, offers an interestingly different take on what is fundamentally different today.  In a one-hour speech at the NAPFA Practice Management & Investments Conference in San Diego on September 22, he connected two dots that most of us are aware of intuitively, but may not have consciously considered.  He said that the primary challenge for investment advisors, financial planners and money managers today, which is different from the challenges you faced in the past, is the sheer amount of attention that individual investors are now able to pay to the ups and downs in their portfolios.

“In the last 15 years,” he said, “we have moved from an era where people who were not in the business would check stock quotes, if at all, in the morning when they got their newspaper.  Sometimes, you would listen to a radio program on your way home from work, and it might tell you what the Dow Jones Industrial Average closed at.”

Compare that with today, when it’s possible to have a running ticker at the bottom of your computer screen, or a portrait of your investment portfolio continuously updating its various components and arriving at new values every 15 minutes.  At the same time, news, information and even fundamental analysis might be flowing into your brain through various sources.  “Regarding the economy and its various indicators, there are probably ten thousand data points that we could be looking at in real time,” Aronstein continued.  “Combine that with hundreds and hundreds of opinions being thrown around as important every day, and it is a formula for driving everybody insane–and I think that really is what is happening to the investing public.”

Put in its simplest terms, we are being driven to an unbalanced mental state by the sheer amount of information and opinions that are piling into our awareness at increasing speed, and nobody has a vested interest in telling us that paying attention is highly unlikely to improve our investing lives.  In fact, to the extent that we feel panic, fear or a concern that we’re missing out on some opportunity, all this information may well be sabotaging the average person’s returns.

If it Bleeds it Leads

Panic is a particularly dangerous emotion to investment portfolios, and there is some evidence that more of it is being artificially manufactured by the media than ever before.  Aronstein pointed out that it has become a pretty good business to give out doomsday information and frighten investors, and a lot of people have become pretty good at it.  “It is rare to spend a day watching CNBC or any of the other financial reality programs,” he said, “and not hear somebody come out with the most disastrous, frightening, extreme forecast about what is going on in the world and in peoples’ portfolios.”

That, in itself, helps us get a better handle on this new era of investing.  Aronstein said that risk assets like stocks, which tend to be liquid and priced every second, become increasingly unattractive in an environment where there is a negative or confusing spin on their every movement.  Who wants to own something which increasingly gives you heartburn and insomnia?  As people sell out of the investments in order to avoid this confusion/heartburn factor, risk assets become more attractively priced than their fundamentals would justify.  This could raise their future returns the same way value stocks enjoy return advantages over sexier growth companies: they are less attractive to the average investor.

Instead, investors might become more interested in investments which aren’t traded every day–such as real estate and certain types of hedge funds.  Because there is no way to watch them change in value in real time, the market commentators aren’t talking about them or offering doomsday scenarios before the commercial break.  Look for these products to proliferate, not necessarily because anybody believes less-liquid products offer better returns, but because they reduce stress.

It would be easy to say that market reality shows represent a scourge on the investing world.  Of course they are unhelpful.  Of course the moment-by-moment market movements and most of the data and opinions are of less than zero value to your financial health.

But the important thing here is for all of us to recognize that a new risk factor has emerged in the investment marketplace.  This emerging “information risk premium” suggests that if you can tolerate (or ignore) the uncertainty and doomsday commentaries while others cannot, you might be able to get better returns for your ultimate retirement.

This post was authored by Bob Veres as a part of his “Client Articles” service.  He is the publisher of Inside Information, an industry leading publication for financial advisors.

Photo Credit: TranceMist

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