The Seed Delusion

Rusty, do you think there is also fear of missing out at work here? For example, I don’t see cryptos as offering any long-term investment value (but if you are able to trade it better than the next guy - which I can’t - go for it) and I’m willing to say, if I’m wrong - so be it; however, some people can’t mentally accept that attitude and find some “smart” sounding “process” reason for putting a small amount of money in cryptos for, in truth, FOMO. The “smart” sounding “process” reason allows them to do what they want to do without having to admit it’s all FOMO driven.

Said another way, a lot of the “process” and “smart” reasoning is reverse engineered from the desire to “cast far and wide.” Some private banks have an allocation (usually one to five percent) to a “fun” or “personal” bucket where clients invest on tips, ideas, etc., that they hear from their friends or the newspaper or somewhere and, one, can’t stand the thought of missing out and, two, like to be able to say at a cocktail party, “sure, I own some of ‘that,’ too” (I’m not making that last point up one bit). It’s a silly thing to do, but the clients love it, and private banks like to make their clients happy. To do so, they need to make it sound thoughtful, so they put it in the allocation model and, as to one of your prior notes, it solves one CAF problem.

The work I did on Behavioural Finance with investment consultant Watson Wyatt (Now Willis Towers Watson) back in 2000 we recognised there are some behaviours clients have, that they do CAF style*, as it SeemsGood but it has no financial value. The real hurdle is net alpha and chasing these micro bets FOMO-wise (as Mark points out) just leads to increased costs (many hidden), and more complex governance for fiduciaries. When one of these little ideas blows up as they eventually do at some stage in the cycle, Regret Risk rears its head and there is a knee jerk reaction to keeping it simple again. Once again with large costs to the investment management structure.

• CAF - Client Acceptance Factor See https://www.epsilontheory.com/c-a-f/

Yes, I definitely think that FOMO is part of the Madame Bovary structure, and is also part of the thing in our brain that convinces us we might have an edge. No question!

I also think that there IS a CAF function to the sort of “fun and harmless” things you point out that every FA will be familiar with. If they want to be long Apple or Netflix as standalone positions, well, it’s not like those aren’t big parts of the equity indices you’re buying for them anyway. But at this stage in the cycle, you start to see the appetites growing from those kinds of CAF items to pursue increasingly aggressive, speculative and (ostensibly) asymmetric payoffs with big effective premium payments. I think that’s where it starts to cross over into malpractice.

I think that’s exactly right, Michael. The question, as both you and Mark point out correctly, is where the line must be drawn. On matters of cost and quantity of risk, CAF has to be a secondary consideration. When we’re talking about true speculative seeds, I think that’s a place where the ethical adviser has to push back.