While there are a number of behavioural biases that can affect investors at any time, there are three worth keeping an eye out for during the Covid-19 pandemic. 
Schroders’ Nick Kirrage (pictured) said such biases can cloud judgement and impair decision-making at the best of times, but these can be exacerbated during times of crisis.
“In highly stressful and unpredictable times like the Covid-19 crisis, there is a greater propensity for this to happen, and it can be highly detrimental to long-term goals,” the fund manager explained.
Ambiguity aversion
The first most common behavioural bias that investors should be conscious of during the pandemic is ‘ambiguity aversion’, said Kirrage, who is co-head of Schroders’ value team and co-manager of the £1.4bn Schroders Recovery fund.
“This is also referred to as uncertainty aversion because it’s about preferring the known over the unknown,” he said. “Such investors tend to invest in what they believe to be safer and more predictable investments.
“The risk is that they opt for investments with lower returns instead of riskier investments which, while they have no certainty of what they will deliver, have potentially higher returns.”
Kirrage continued: “There are no certainties when it comes to fund management, only various possible outcomes and various probabilities these outcomes will happen.
“It’s extremely hard to take low risk and make big returns so we have to constantly remind ourselves that the more certain we are in our views, the less likely we are to make big returns for clients.”
He added: “A sweet spot exists where you have confidence – but not certainty – in your forecast for a company, but can still make good returns from the investment.”
Loss aversion
Another common behavioural bias among investors during times of crisis is ‘loss aversion’, which Kirrage said often results in investors trying to avoid losses at all costs rather than considering alternatives.
“The risk is that they miss out on good gains because the anticipated emotional consequences of loss are too much to bear,” the Schroders manager said.
“Loss aversion is one of the most powerful human biases,” said the manager. “There are no fail-safe ways to avoid it, but my tip would be to force yourself to put numbers around your negative predictions: work out the implied probability the current market share price puts on a company going under.”
Kirrage drew comparisons with the 2008/2009 global financial crisis when the banking sector came under huge pressure and forced the team to work out the probability that certain banks would become bankrupt.
“We performed this exercise and the market seemed to believe there was an 80 per cent chance a number of banks would go bust,” he explained.
“This probability seemed way too high and allowed us to turn our focus away from our fear of loss and onto the idea that ‘if the market is already very confident any investor will lose money today, surely there’s a lot of money to be made if things are only marginally less bad than assumed?’.”
Optimism bias
The last behavioural bias investors should recognise is ‘optimism bias’ “the tendency to overestimate the likelihood of success compared with the likelihood of failure”.
“This is only a bad thing if it leads to you ignoring key warning signs or missing the potential pitfalls of an investment because you’re being overly optimistic about its prospects,” Kirrage explained.
“Used in the right way, the tendency to be optimistic can be a good thing.”
Rather than looking to avoid optimism bias, the Schroders manager said it is better to redirect it.
“Instead of being optimistic about companies that are already doing well and trade at expensive valuations, we try to redirect this optimism towards companies that are currently suffering and have low valuations,” he said. “What if these companies can recover? What if their current ills are not permanent?”
These companies tend to have a combination of low valuations and low expectations, which for a value investor can be a rewarding place to invest.
“By using our natural optimism in a more contrarian way – being optimistic about less loved stocks –and in a less herd-like way – being optimistic about well-loved stocks – we can look to make better returns for clients,” he concluded.