Financial advisers’ cognitive bias over rand and section 12J funds has cost investors

Amid worldwide panic last year about the effect the Covid-19 pandemic would have on economies, many South Africans were given advice by their financial advisers that, in hindsight, turned out to worsen their financial situations.

In April 2020 the rand reached a record weak level of R19.35 to the dollar, a sudden slump most likely caused by: 

• The SA government's imposition of an exceedingly restrictive economic lockdown.
• Fitch’s downgrade of the country’s credit rating.
• The predictable sell-off of emerging-market currencies and equities as investors rushed to the safety of developed markets.

Though there was clear economic danger ahead, many technical analysts and economists asserted correctly that the rand was dramatically undervalued, especially in contrast to emerging-market peers such as the Brazilian real and the Turkish lira. In fact, the local currency was merely after a pattern we have seen many times before: market volatility in SA is followed by overdivestment in the local currency.

Usually — as with the 2000s dot-com bubble crash, the 2008 global financial crisis and the Zuma-Nene scandal in 2015 — a decisive recovery in the rand-dollar exchange rate follows as investors quickly realise the rand is undervalued.

This is not a ground-breaking insight that was unavailable to the public. On April 6 2020, for example, just days after the rand hit its peak weakness against the greenback, BusinessTech reported that the Bureau for Economic Research had argued that the rand would be trading at much stronger levels within a year.

Despite the strong likelihood that the rand’s weakness in March-May 2020 would be short-lived, I have been shocked to discover that thousands of South Africans were advised by their financial advisers to move their money offshore at this time, especially into dollar-denominated investments. To date, those investors have lost up to 30% on their investments in rand terms on the exchange rate alone.

Confirmation bias

While it is true that no-one, financial advisers included, can predict the future, especially at times of uncertainty and crisis, it would be a mistake to let professionals who give poor advice off the hook so easily. An adviser’s job is to use specialist knowledge and expertise to help clients make educated guesses about how to handle their finances, a job for which they are often handsomely rewarded. Part of this task is guarding against what is known, in finance and in psychology, as cognitive bias.

A cognitive bias is a recognisable pattern of flawed thinking that causes irrational decision-making. It happens because we tend to make up our own “mental stories”, which change the way we look at objective facts. A specific kind of cognitive bias that is crucial to recognise in financial decision-making is confirmation bias. This is the tendency to favour information in decision-making that favours our pre-existing beliefs. It is irrational because it leads to us ignoring good evidence contrary to our beliefs, because it doesn’t fit in with our “mental story”.

Many financial advisers in SA seem to hold a deeply entrenched belief that offshore investment, especially in foreign equity, is the only way to go for local investors. Reasonable fear about SA’s future has led to an unreasonable discounting of local asset classes that, if we calmly look at the evidence, still offer attractive prospects for investors. Moreover — and this is where confirmation bias comes in — any volatility in local markets and any negative political or economic news is taken as evidence for this belief.

The bluntest example of this has been how so many SA financial advisers have advised against investing in section 12J funds. Though these investments literally offered investors free money in the form of a tax rebate — up to R1 of value for every 55c invested by a taxpayer, before any growth in the underlying investment — many financial advisers have told their clients that they were too “high risk” to consider.

Take advantage

This was bad advice. Grovest’s 12J funds, for example, performed well for their investors, delivering dividends and growth on capital even throughout the pandemic. Rencell Solar, a 12J renewable energy fund with a specific focus on advancing solar panel adoption in the residential sector, has declared an annual 5% dividend since inception and is on track to deliver a more than 20% internal rate of return (IRR). Asset rental fund Sunstone Capital and cannabis-industry fund SilverLeaf Investments are on track to deliver 18% and 20% IRR respectively.

With less than a week left to take advantage of section 12J, I hope I can offer some guidance to investors. It is always important to take your financial adviser’s advice into serious consideration. After all, advice is what you are paying for. But it is also important to recognise that financial advisers fall into the same fear-based cognitive traps that we all do.

We are all prone to cognitive bias and blind spots, and I always encourage clients to ask the reasons for the advice they are given, to interrogate whether there is something that has been missed and even ask around for a second opinion. This is the best way to ensure investors are rationally building a sound investment portfolio that spreads and anticipates risk — the best shot at steady wealth creation in the long term.

• Miller is CEO of Grovest, SA’s largest administrator of section 12J venture capital companies.