FEATURE: MEAN VARIANCE
EXECUTIVE SUMMARY
• There are a number of tools that
help investors calculate whether
future returns have a greater or
lesser chance of refl ecting past
performance.
• The combination of a negatively-
sloped yield curve, excessively tight
credit spreads and expensive
valuations would have served as a
warning.
• Behavioural fi nance explains why
these potential warnings went
either unnoticed or ignored.
BY: DANIEL MURRAY, CFA
E
ven to seasoned investors,
recent activity has been beyond
the realms of experience or
expectation. An investor who
purchased a basket of equities twenty
years ago would now be only marginally
better off than someone who had
bought a basket of governemnt bonds
and this is before adjusting for
diffdiff ererences in risk. Fence or example, the
Challenges to
cumulativcumulative return on US equities over
the ten ythe ten years ending in De ec 2008 was
-15.5% compar-15.5% c ed with a cumulative
return on US goeturn on vernment bonds of
market effi ciency
nearly 80%. Thnearly 80 e cumulative return on
US equities oUS equiti ver the twenty years
ending in Dending in ec 2008 was 417%
compareed with a cumulativd e return on
In the months lIn the months leadineading up tg up to the credit crunch
US goUS goveernment bonds of 358%. Thr e
tenet that invtenet that estors should be rewarded
therthere was plenty of information that warned of for purfor purchasing higher-risk assets has ch
its arrivits arrivalal, so why did so fso why did so feww peoplpeoplee spot it?spot it?
thertherefore pre oven to be bad advice. By
itself this is not in confl ict with standard
The answer, writes Daniel Murray, CFA, lies in fi nance theory. Th e important point is
the irrational behaviour of investors, who
whether or not a well-informed rational
investor could have anticipated these
either could not recognize the signs or events based on information available at
couldn’t bear to change their tactics
that time. If this can be shown to have
been the case, it presents a challenge to
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