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FINM3407 Assignment
FINM3407 case study
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Finance (FINM7401)
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University of Queensland
Academic year: 2024/2025
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FINM3407 Assignment
5 pages
1. How and to what extent can investment advisors/portfolio managers attempt to add value?
How should Rudy Wong advise Bob Miller and the Kleins? Discuss with the lens of
“behavioural finance”. [30 marks]
A portfolio manager has a very similar role in which a person or group are “responsible for investing
a mutual, exchange traded or close-end fund’s asset, implementing its investment strategy, and
managing day-to-day portfolio trading” (Chen, 2021). In Rudy Wong’s role as an investment advisor,
he provides comprehensive financial planning and selling of securities to his retail investor clients,
aiming to help optimize the allocation of their financial assets, in order to meet their specific
financial needs (Case study). By considering his client’s specific financial resources, constraints and
both short and long-term objectives, Wong can attempt to increase portfolio value by strategizing an
appropriate asset allocation given his client’s preferences in securities. Additionally, applying a
knowledge and understanding of behavioural finance, Wong can tailor his advice to his clients Bob
Miller, and the Klein’s individual needs to maximise their portfolios profitability.
It was found in Brinson and colleagues 1986 paper, that a portfolio’s total return and volatility over
time was largely contributed by investment policy, the long-term asset allocation plan selected to
control risk and meet fund objectives, rather than market timing and security selection.
Robert Merton (1981) investigated the idea of security selection based on market timing, and that if
market participants were rational, superior performance could be achieved through superior
forecasting skills on part of the performer. These evaluations were developed to test the Efficient
Market Hypothesis. Market timing, also known as macro forecasting, is the prediction as to whether
equities are under or over-valued, relative to fixed-income securities. As such, investors attempt to
forecast when the stocks will outperform the bonds, and when bonds will outperform stocks. In this
study, Merton identified how investors would use the market timer’s forecast to modify their
probability beliefs about stock returns, and as a result influence their investment behaviour.
(Merton, 1981). In 2005, Dr Tokat reviewed this investment strategy and found that market timing
was an inefficient method in producing positive returns and found that the ultimate concern was to
whether active management could increase returns and reduce the risk of a portfolio. Furthermore,
the study found that the most optimal way for an investor to add value was through asset allocation.
The study found that investor should focus on asset allocation, which is relatively “controllable”, as
well as having a diversified portfolio with limited market timing (Tokat, 2005). Therefore, the most
optimal way in which investor can attempt to add value, is through focusing on specific asset
allocation, investing in long-term assets with high returns and low volatility, rather than focusing on
market timing or security selection.
Behavioural finance examines how psychology influences market participants behaviour, and how
such behaviour affects market outcomes. There are two main theories related to how cognitive
biases and emotional aspects contribute to investors decision making; expected utility theory and
prospect theory. Expected utility theory attempts to provide mathematical explanations of financial
questions and assumes that markets are efficient and highly analytical. (Antoy, 2019). In 1979,
Kahneman and Tversky developed ‘Prospect Theory’, which challenged the traditional economic
model of decision-making under risk. This theory offered a representation of truly rational investor
behaviour, stating that investors are risk averse, introducing the concept known as loss-aversion
(Antoy, 2019). Understanding the behavioural assumptions that influence investment decisions can
help define what an optimum portfolio is, by aiding in selection of the best investment options.
(Antony, 2019).
Individuals have varying levels of monetary intelligence, defined as “individual’s money attitudes to
elaborate techniques to achieve financial happiness”. As a result, the trading behaviour of investors
also varies, and can be categorized into four sections: “risk intolerant, confident, less risk-averse
young, and conservative long-term investor” (Nadeem. et al, 2020). By understanding these
behaviours, inventors can tailor their clients’ portfolios to these specific risk needs.
Wong analysed that his client, Bob Miller was affected by multiple heuristic bias’, including excessive
optimism, confirmation bias and illusion of control. The framing effects influencing his financial
decision making included the notion of loss aversion. Helping Miller overcome these decision-making
biases will help him achieve his financial goals. Loss-averse and narrow framing investors evaluate
gains and losses on securities in isolation, rather than integrating their entire portfolio. As a result,
they avoid investing in individual stocks to a greater extent than they avoid mutual funds (Dimmock,
2008). In order to overcome these bias’s as a loss-averse investor, Wong can ensure that Miller does
not avoid investing in induvial stocks, and ensure he holds a diversified portfolio selected by asset
allocation, in order to achieve his long-term financial goals.
client meeting to be set in March 2009 – just after the GFC
- Find evidence of economic downturn and the effect of such on each clients specific
investment portfolios
- What bias do the customers reflect, and how is this expected to influence their attitude to
the likely outcome of their investments
- What can Wong do to advise his clients in order to avoid the biases they represent, while
adhering to the specific goals and risk tolerance they have in place
The most effective approach for investors to minimize behavioral biases
such as risk aversion and confirmation bias is through diversification and
strategic asset allocation. Diversification spreads investments across
various asset classes and sectors, reducing the impact of individual stock
or market fluctuations on the portfolio. Strategic asset allocation
establishes a long-term investment plan that aligns with the investor's risk
tolerance and goals.
Research supports the benefits of these strategies. Brinson et al. (1986)
demonstrated that a portfolio's total return and volatility over time were
primarily driven by the long-term asset allocation plan rather than by
market timing or security selection. This underscores the importance of
establishing a solid investment policy to manage risk and achieve
investment objectives.
Additionally, Robert Merton (1981) explored the impact of market timing
on portfolio performance, suggesting that if market participants were
rational and possessed superior forecasting skills, they could achieve
better results. However, later research by Tokat (2005) found market
timing to be an inefficient method for generating positive returns,
highlighting that asset allocation and diversification are more effective
strategies.
Tokat (2005) emphasized that the most optimal way for investors to add
value is by focusing on asset allocation and maintaining a diversified
portfolio with limited market timing. This approach allows investors to
invest in long-term assets with higher returns and lower volatility, rather
than attempting to predict market movements through market timing or
security selection.
Investors can minimize behavioral biases like risk aversion and
confirmation bias through diversification and strategic asset allocation.
Diversification reduces the impact of individual stock or market
fluctuations, while strategic asset allocation aligns an investment plan
with the investor's risk tolerance and goals.
Research supports these strategies. Brinson et al. (1986) found that long-
term asset allocation primarily drives a portfolio's total return and
volatility, underscoring the importance of a solid investment policy to
manage risk and achieve objectives.
Merton (1981) investigated the impact of market timing on portfolio
performance, suggesting superior forecasting could lead to better results.
However, Tokat (2005) later found market timing inefficient for generating
positive returns, emphasizing that focusing on asset allocation and
diversification is a more effective approach.
Tokat (2005) highlighted that investing in long-term assets with higher
returns and lower volatility, rather than attempting to predict market
movements, is the most optimal way for investors to add value.
REFERENCES (APA)
Fernando (2024)
investopedia/terms/i/investmentadvisor.asp
Chen (2021)
investopedia/terms/p/portfoliomanager.asp
Gary P. Brinson, L. Randolph Hood, & Gilbert L. Beebower. (1986). Determinants of Portfolio
Performance. Financial Analysts Journal, 42 (4), 39–44. jstor/stable/
Tokat, Y. (2005). The Asset Allocation Debate: Provocative Questions, Enduring Realities. Vanguard
Investment Counselling & Research
enhance their understanding of their clients’ preferences by understanding what biases may be
influencing them, and therefore create an insightful investment strategy best suited to inform their
recommendations and investment decisions.
It can be argued that the primary determination of a portfolio’s performance is asset allocation, thus
the investment advisor’s selection of assets can influence the value added to the portfolio.
In 2005, Dr Tokat reviewed this debate and application of financial theory, and found that the
ultimate concern was to whether active management could increase returns and reduce the risk of a
portfolio. It was found that on average, whilst creating an opportunity for a portfolio to outperform
the benchmark, actively managed portfolios experienced a decrease in returns, and higher volatility
in comparison to a static index.
Bob Miller:
- Doesn’t want to change strategy due to short-term losses – risk-aversion
- Insisted on investing on risky stocks subject to great cyclical volatility despite advisor advice
- Wong believes the cyclical nature of the investments means Bob should remain patiently
invested notwithstanding the current downturn as the economy’s inevitable recovery should
result in a surge in oil and gas stocks and the equity markets more generally
- Subject to emotional distress due to volatility of global financial markets – Losses loom
significantly larger than gains for Miller – loss aversion
- Miller’s emotions were dependent on the performance of the overall market sentiment
- He had biases in excessive optimism, overconfidence. Confirmation bias and illusion of
control as well as framing effects including the notion of loss aversion
- by addressing all these problems, he can help Miller overcome the decision-making
pitfalls in order to best achieve their long-term goals
The inefficiency of using market timing to generate returns can be explained by the flaws in
market efficiency.
The extent to which investors can control the outcome of their stocks is limited as they
effectively cannot control the way in which the market operates. Rather than attempting to
control performance through market-timing and the selection of securities, having a long-term
goal and focusing on asset allocation will allow for the best performance.
Market timing:
Given the evidence above, it can be determined that in order for investor to add optimal value
to their clients portfolios, they should strategies in asset allocation, which allows for the entire
portfolio to be shielded from the fluctuations of a single stock, or class of securities (Croome,
2024).
Therefore, the most efficient way for advisors to add value is through a good asset allocation
strategy that diversifies risk, and by doing so, offers insurance through market downturns (Pryor,
2018).
The Kleins:
- Both have calm temperaments and are suited to long-term investments
- Large exposure to equities, become nervous when stock prices drop – loss averse
- Wong wants to maintain their current asset mix and show them that a market low might
provide them to invest more in equities, lowering their overall investment cost base and
potentially realizing further gains the future
- Wanted to reiterate that historically, equities were the only asset class capable of return
that would enable the Klein’s to realize sufficient growth for retirement savings
- However, he also is wary that the Kleins may view his preposition as self-serving, seeking to
gain more assets under his management
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FINM3407 Assignment
Course: Finance (FINM7401)
29 Documents
Students shared 29 documents in this course
University: University of Queensland
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FINM3407 Assignment
5 pages
1. How and to what extent can investment advisors/portfolio managers attempt to add value?
How should Rudy Wong advise Bob Miller and the Kleins? Discuss with the lens of
“behavioural finance”. [30 marks]
A portfolio manager has a very similar role in which a person or group are “responsible for investing
a mutual, exchange traded or close-end fund’s asset, implementing its investment strategy, and
managing day-to-day portfolio trading” (Chen, 2021). In Rudy Wong’s role as an investment advisor,
he provides comprehensive financial planning and selling of securities to his retail investor clients,
aiming to help optimize the allocation of their financial assets, in order to meet their specific
financial needs (Case study). By considering his client’s specific financial resources, constraints and
both short and long-term objectives, Wong can attempt to increase portfolio value by strategizing an
appropriate asset allocation given his client’s preferences in securities. Additionally, applying a
knowledge and understanding of behavioural finance, Wong can tailor his advice to his clients Bob
Miller, and the Klein’s individual needs to maximise their portfolios profitability.
It was found in Brinson and colleagues 1986 paper, that a portfolio’s total return and volatility over
time was largely contributed by investment policy, the long-term asset allocation plan selected to
control risk and meet fund objectives, rather than market timing and security selection.
Robert Merton (1981) investigated the idea of security selection based on market timing, and that if
market participants were rational, superior performance could be achieved through superior
forecasting skills on part of the performer. These evaluations were developed to test the Efficient
Market Hypothesis. Market timing, also known as macro forecasting, is the prediction as to whether
equities are under or over-valued, relative to fixed-income securities. As such, investors attempt to
forecast when the stocks will outperform the bonds, and when bonds will outperform stocks. In this
study, Merton identified how investors would use the market timer’s forecast to modify their
probability beliefs about stock returns, and as a result influence their investment behaviour.
(Merton, 1981). In 2005, Dr Tokat reviewed this investment strategy and found that market timing
was an inefficient method in producing positive returns and found that the ultimate concern was to
whether active management could increase returns and reduce the risk of a portfolio. Furthermore,
the study found that the most optimal way for an investor to add value was through asset allocation.
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