Investors are plagued by two emotions – greed and fear. Only those who actively invest in the stock market know how difficult it is to control them. The great gravity of the problem meant that even the Swiss government obliged financial institutions to act to increase investor protection. In this article you will learn how the FINGO development team helps to meet the regulatory challenges and what dolphins, deer, elephants and eagles have to do with it?
Emotion is the enemy of investing
The 2008 global financial crisis was a perfect example. Investors faced highly volatile markets, sharp price corrections in most asset classes, a breakdown in liquidity and a painful recession. Even professional traders were struggling to keep their cool .
But investors have to make tough decisions almost daily. According to a survey by Magnify Money, 47% of investors admitted to have difficulties keeping their emotions in check when managing a portfolio. 66% did regret decisions made under the influence of emotions. Interestingly, in the case of generation Z (born 1995-2010) this number climbs to a whopping 85 percent, only slightly more in control of emotions are the Millennials (born 1980-1995)have their emotions only slightly better under control as 73% regret their impulse decisions.
“It is very difficult to determine the actual extent of this problem. But we often notice, that clients exit markets or make larger transactions in volatile times such as the current one. But there are also clients who use such situations as an entry opportunity”, says Süleyman Saggüc, Senior Investment Manager at HBL Asset Management.
Financial institutions try to help investors
Investor behaviour has fascinated scientists for years, and this topic has become the subject of many research papers. In 1979, the book «Prospect Theory: An Analysis of Decision under Risk» was published by Daniel Kahneman and Amos Tversky. It is here that researchers described a number of cognitive errors made during economic and financial decisions, e.g. excessive loss aversion, attachment effect and many others. Besides, in 2002 Kahneman won the Nobel Prize in Economics “for having integrated insights from psychological research into economic science, especially concerning human judgement and decision-making under uncertainty”.
But the susceptibility of investors to making fatal decisions under the influence of emotions was also noticed by the Swiss government. As a response to these concerns a new law was introduced. In January 2020, under the provisions of the Swiss Financial Services Act (FIDLEG), it obliged financial institutions with a transitional period of two years to introduce more comprehensive protection for investors. The new regulations applied to companies based in Switzerland, or acting for the benefit of clients residing there. The regulator has not specified in detail the methods of compliance with the regulations. As a result, different institutions have adapted differently.
As part of adapting to these regulations, HBL Asset Management, the asset management brand of the Swiss bank Hypothekarbank Lenzburg, with entrusted assets of CHF 950 million at the end of September 2022, decided to create a unique approach based on a commercialized mathematical model.
“We decided that we would like to introduce a new risk profiling tool. In this process, we faced challenges and opportunities, says Süleyman Saggüc. “We analyzed various providers, whereby the consideration of emotions and behavior were key criteria for Hypothekarbank Lenzburg. In the end, we chose the model of Behavioural Finance Solutions GmbH by Enrico De Giorgi and Thorsten Hens.ˮ
Risk Profiler – an application profiling investors
An investor's knowledge and the level of risk tolerated are verified with the use of an internal banking application. Based on the answers provided, the bank's client receives recommendations regarding financial instruments. People who are susceptible to emotions and have less market knowledge are offered safer asset management models. On the other hand, those who are more knowledgeable, models are recommended that allow them to make independent investment decisions. Of course, the final decision on the composition of the investment portfolio rests with the client.
“The risk profiler is used for all clients who request an advisory solution or asset management advice from Hypothekarbank Lenzburg. This means that, apart from execution-only clients, the risk profiling tool is used for all private clients. For us, it is important that the client takes conscious and acceptable risks that fit his or her personal risk profile. The goal is to accompany and clarify the client in the best possible way so that no careless investment decisions are made”, says Süleyman Saggüc
The risk profiler is used in a personal consultation meeting with a client advisor from Hypothekarbank Lenzburg. Besides that, the HBL Asset Management also uses a scaled-down and web based version of the risk profiler for marketing purposes. The application determines the investor's profile on the basis of a multi-level questionnaire. The great advantage of the questionnaire is its non-linearity, which allows for a unique diagnostic session and the creation of a client profile.
In the marketing version of the risk profiler tool the results are intentionally presented in a playful manner to make it as easy as possible for clients to access the complex world of finance. The character of the investor is represented by an animal:
- The dolphin likes to be guided by feelings and jump into the unknown.
- The deer is famous for its self-confidence in stressful situations.
- The elephant is characterised by careful steps, slow decision making, and avoidance of excursions into the unknown.
- The eagle is an investor who sees the bigger picture.
Challenges faced by FINGO developers
The implementation of the above-mentioned mathematical model was quite a challenge. Therefore, the FINGO development team designed an appropriate domain model and applied detailed tests: unit tests and end-to-end tests of the user interface.
“Accurate tests, especially of boundary conditions, made it possible to detect situations in which the mathematical model needed to be adapted by its author. Thus, our team contributed to the development and improvement of Professor Enrico De Giorgi's mathematical model, says Tomasz Gadula, FINGO Project Manager.
The questionnaire itself is divided into sections and implemented using a hexagonal architecture (adapters and ports). This results in the above-mentioned non-linearity effect. Equally important is the attractive appearance of the interface, which the UI designers looked at. Various types of graphs presenting numerical data or the use of drag-and-drop functions in places make the use of the application a pleasant experience. Moreover, the solution does not omit the knowledge aspect, which is deepened by an “Investing in a Nutshell” course based on a series of interactive slides.
Developers have also adapted the product to mobile devices, thanks to which there are already three separate solutions using a common core: the intra-banking application for client advisors and the web based tool for mobile and desktop devices.
Cool calculation thanks to IT solutions
“Our tool helps us to determine for each client the risk class that suits their individual profile. Once the client's risk profile has been determined, the client makes the investment decisions with the assistance of his client advisor. The focus is always on the portfolio context. So it is not the tool alone that helps to make investment decisions”, says Süleyman Saggüc. “However, the tool shows how strongly a client is guided by emotions when making investment decisions. We advise clients who are strongly driven by emotions to delegate their investment decisions to the professional investment advisors of Hypothekarbank Lenzburg.”
Access to the investment profiler of the HBL Asset Management (German only) - https://investment-profiler.hbl.ch/