Fund managers must understand the role of emotion in investments

According to Flynn Robson, head of asset management at Emperor Asset Management, it is the job of asset managers to understand the role that emotion plays in investments and to try and remove that from their clients. "It is remiss of those operating within the investment industry to believe that emotion doesn't play a huge role in investing. It is there and it cannot be ignored, so investment firms need to put in place measures that can deal with it."

He says first and foremost asset managers need to understand where the emotion arises from. "There are various levels of risk and it is only through understanding the risk that one is able to mitigate the level of emotion involved. For example, if you expect a return of 20% and you are happy to take a 10% risk score then the emotion will be set aside but if the risk edges towards the 80% mark, clearly there is far more emotion involved."

Emotion can be positive

Robson notes, however, that emotion can also be a positive factor. "Emotion drives consumption, so for the retail investor there needs to be some form of emotion within investing to encourage them to act. From the fund managers' side however, the level of emotion depends heavily on the intended length of the investment."

In many instances, the fund managers may only speak to the clients once a month or once every three months. "As a result, the client often feels they have to hold in any emotion in until the reports are published at the end of every month, which can be hugely destructive. Regular communication, even through new technologies, is crucial.

"To effectively manage the emotion on the part of the client, the asset manager has to be transparent, explaining everything on a regular basis. If you are honest and open, explaining exactly how the fund is performing, it will attract emotion but the manager can then deal with that as it arises. If a client knows that when the markets are less stable and they are feeling more emotional, they are able to speak to their fund manager, they feel more reassured," Robson says.

Communication in a crisis

He says this was the case in the global financial crisis of 2008/09. "Everyone was so busy trying to deal with the situation that no one was communicating to the client, so they were left to panic and as a result, people withdrew their money after the markets tanked - at the worst possible time, thereby consolidating their losses.

"When a crisis occurs, the one person that people don't want to talk to is the client. Once again it is emotion, this time on the part of the fund manager because it's an uncomfortable conversation to have. However, one has to overcome that and speak to the client regularly, particularly when the market is underperforming as, to some extent that will remove negative emotion," he concludes.