The Pied Piper of Pensioners

Research Retrieved: January 2017 (PDF below)
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Using the case of the mandatory contribution pillar of the Chilean social security system, Cuevas and Bernhardt (2016) illustrate how sensitive individual investors are to investment advice and how this can lead to extreme asset shifts around the release of new advice. The Chilean system limits investor choice to picking one out of five pre-defined portfolios with increasing risk exposure. The authors show that advice to switch from low-risk to high-risk portfolios and vice versa - given by a single advisory firm named “Happy and Loaded” - led to investment shifts frequently exceeding 1.3% of the Chilean GDP in a week.

Key Findings

  • Development over time: The magnitude of the reactions to the investment advice given by a single investment advisor with wide reach and an offer targeted at private investors strongly increased over time. This amplification is explained by the observation that investors “came to believe” the directions provided by the advisory firm: Initial advice given on portfolio reallocations would indeed have been value-enhancing for switching investors.
  • Source of investment advice: Based on the analysis of asset returns, it appears that the issued recommendations the advisor gave were based on immediate past market performance. For instance, the advisor recommended switching to a pre-allocated portfolio with more equity exposure after two days of high Chilean stock market and simultaneously low bond returns.
  • Wealth loss for investors: After the advisor had issued a series of recommendations followed by mass reallocations, investment advice and subsequent rising demand were immediately priced in. Since pension administrators in Chile only execute reallocations with several days of delay, individual investors reallocating large parts of their portfolio therefore faced severe losses. They were always worse off compared to scenarios of sticking to the initial portfolio choice and asset allocation.
  • Besides stock returns, the daily exchange rate to the U.S. dollar and the returns on 10-year indexed government bonds were affected by the large re-allocations, experiencing significant positive cumulative abnormal returns after recommendations and turnover surges, later followed by slight reversals.


Practical Relevance

This study might be useful for practitioners interested in the construction of quantitative risk-management models. It sheds light on how to hedge against stock market inefficiencies following an under-reaction to information about prolonged droughts especially since the findings show that PDSI might be a very useful metric of drought to build portfolios and manage risks.