Summary: A new study from QUT offers a warning on investor attitudes to hybrid securities. Participants were tested to reveal behavioural biases and risk attitudes, then asked to allocate bonds, hybrids and shares to an investment portfolio. Participants who had an illusion of control or an over confidence bias allocated more hybrids to their portfolios than others. Participants acknowledged poor knowledge of hybrids, but this did not deter them from buying the securities.
Key take out: The findings appear to confirm ASIC’s fear that retail investors are attracted to the appearance of secure, steady, “bond-like” returns from hybrids.
Key beneficiaries: General investors. Category: Hybrid securities.
The Australian Securities and Investments Commission has long been concerned about hybrid securities. ASIC fears that retail investors do not understand the complexities of hybrids and the degree of risk involved. Investors may be attracted to hybrids because of a perception of secure, steady, “bond-like” returns.
ASIC has published guidance on hybrid securities on its MoneySmart website and every so often a notice headed “ASIC guidance for retail investors” or words to similar effect will appear within the first few pages of a hybrid prospectus.
More recently however, ASIC commissioned a study by Queensland Behavioural Economics Group (QuBE) to examine the behavioural biases that influence investor decision making in relation to hybrid securities. QuBE is a part of Queensland University of Technology’s business school and the findings of the study are intended to assist ASIC to effectively communicate risk to the public and enable informed conversations with industry.
Behavioural economics recognises that human beings are not rational economic units, as economists have traditionally assumed. Recognition is given to the biases that can influence decisions, such as investment decisions.
In this study, university students with generally little knowledge of hybrids (much like many retail investors) were placed in a simulated environment, where researchers could control the factors affecting the decisions made. Many field experiments have confirmed the findings of laboratory experiments such as this, and the laboratory experiments have the advantage of allowing environmental factors that could influence findings to be blocked.
After being tested to reveal behavioural biases and risk attitudes, the students were asked to allocate bonds, hybrids and shares to an investment portfolio. The kicker for the students was being able to keep the “returns” generated by their portfolio.
The study found that participants with an illusion of control bias allocated 14 per cent more hybrids to their portfolios than those without such a bias. The bias is one where the holder believes they can influence or control the outcome of an uncertain event, even though they cannot.
An over confidence bias is a misguided sense of one’s ability to act early and reduce risk, if need be. Sufferers of this bias had a 10 per cent greater allocation to hybrids than others.
Combined with an illusion of control investment portfolios could become concentrated: lacking in diversification.
A framing bias is the tendency to make different choices depending on how those choices are presented. This bias can be more pronounced with hybrids, as many of the risks are not immediately apparent.
Thus, the risk return profile can seem more appealing than the risk return profiles of bonds and shares. Again, those suffering from a framing bias made a 10 per cent greater allocation to hybrids in their portfolios.
Interestingly a preference for known risks over unknown risks, referred to as ambiguity aversion, led to an 11 per cent higher allocation to shares in participants’ investment portfolios. This finding appears to highlight perception of the risky nature of hybrids.
Lastly, a branding bias, where one might make investment decisions based on name familiarity, was not found to influence investment choices. This is a surprising finding given that it has long being assumed that this is exactly what happens when investors buy hybrids.
The researchers argue that this may be the result of information being provided to participants in a succinct and standardised manner, and if nothing else, provides an opportunity for further research.
As for the risk attitudes of the participants, it was found that while participants acknowledged a distrust of issuers and products and poor knowledge of hybrids, it did not deter participants from buying hybrids. This outcome is attributed to a possible framing bias such that participants focused on certain obvious features of hybrids and ignored important descriptive information.
This last finding appears to confirm ASIC’s fear that retail investors are attracted to the appearance of secure, steady, “bond-like” returns from hybrids. They are being sold the sizzle.
It will be interesting to see how ASIC responds to the findings of the study and whether further research is undertaken.
Philip Bayley is a former director of Standard & Poor's and now works as an independent consultant to debt capital market participants. He also writes on matters concerning debt capital markets and banking for various publications and is associated with Australia Ratings.