One of the more compelling and curious experiments that was conducted by Kahneman and Tversky in the 1970s proved that investors do not make rational decisions in taking risk. This experiment, conducted using a group of over one hundred college students to determine decision outcomes, was one of many experiments they conducted during their intense period of work during which they effectively invented the science of behavioural economics. Specifically, in this experiment, they proved that investors tend to take more risk in the face of loss, than they would under the prospects of making a gain. The experiment is clearly laid out in several books, including Kahneman’s own as well as in the recently published Michael Lewis account of the collaboration that led to a fundamental rethinking of the underlying assumptions of investment science.
In short, the experiment demonstrated that investors, when facing the chance of losing, take more risk than when facing the chance of winning, even when the outcomes are probabilistically equivalent. Kahneman and Tversky used university students as proxy for investors. Students were given a choice between a certain loss of USD 50, or a 50 percent chance of a zero loss and a 50 percent chance of a USD 100 loss. This was called Group B. A separate group of students was given the opposite choice: a certain gain of USD 50 or a 50 percent chance of a USD 100 gain and a 50 percent chance of a zero gain. This was called Group A.
Unexpectedly, the experiment found that when facing potential loss, investors take substantially more risk. To a large degree, this simple experiment demonstrates the apparently illogical phenomenon of gambling as a human endeavour and the perennial success of Las Vegas and Macau. Loss, for reasons that cannot be explained by the Capital Asset Pricing Model, seems to engender a desire to take further and even greater risk. Basically, investors seem to repeatedly throw good money after bad.
There is then to be found in behavioural economics some explanation for the otherwise inexplicable behaviour of the Qatari investment funds. Having made three rounds of heavy capital investment into the Deutsche Bank brand over the past six years – each round of which has led to substantial losses – they have in March of 2017 made a bid in partnership with Bob Diamond, previous CEO of Barclays, for the London loss- making broker Panmure Gordon at a substantial premium.
Qatar, along with other Arab-speaking states including Libya, had been sold post-crisis a story that went something along these lines: large diversified multinational banks had been oversold post-crisis, their price earnings ratios were substantially lower than diversified industrial firms, they would rebound and they would rebound strongly. It is somewhat ironic that it was investment banking salespeople from other large diversified banking groups that sold this story, including firms such as Goldman Sachs and Credit Suisse. Public investment funds from primarily Arab states were encouraged to take substantial risk on specific banks that were viewed as particularly under-priced.
In the cases of the state-run Libyan investment fund and the Qatari investment funds, these bets turned out to have no downside protection and experienced significant losses, in some cases of up to 80 percent of book value. In the last round of capital raising that Deutsche Bank went through it was therefore surprising that the Qataris were tapped for cash yet again.
Bob Diamond too has had a tumultuous time of it of late. At one point, post-crisis, he was regarded as being one of the most credible investment bankers of the modern era. He was handed the helm of Barclays at a time when Barclays was looking stronger than its peers on several fronts, but then in 2012 had to resign under the cloud of the LIBOR rigging scandal. Since then he has driven the creation of Atlas Mara, a unique offering from an investment perspective: an Africa-specific bank holdings company, which would take stakes in a wide range of African banks.
Atlas Mara, like the Deutsche Bank stakes that Qatar has held, has experienced value erosion of more than 80 percent since its listing in 2013. Whereas Deutsche Bank has been ravaged by continued problems with their capital adequacy levels, their inability to sell Deutsche Postbank, and the poor performance of their investment banking division, Atlas Mara has suffered from the macroeconomic reality that African growth was driven primarily by Chinese demand and a commodities price boom.
The Chinese growth story is finally coming to a halt, even though it is being propped up to some extent by Chinese market intervention. And the commodities boom, for the foreseeable future, is over. Both parties then, the Qataris and Bob Diamond, are therefore part of Group B, the loss-facing group, to use the language that Kahneman and Tversky used.
Their proposed investment in Panmure Gordon, a mid-cap stockbroker and investment bank of former glory based in London, does not seem to be an investment that will necessarily alleviate the blood-letting that the Qataris and Diamond have been suffering.
At best, it involves a leap of faith to accept that the firm can be turned around. There are no specific details as to how this would occur, especially given the fact that Diamond has not clarified that he would be intimately involved in the running of the firm. Like many other brokers, Panmure Gordon has come under increased pressure over the last several years in the face of increased regulations such as Mifid II, and extensive pressure on pricing. The firm, however, has suffered more than most, with several abrupt structural and management changes in only the past year.
At worst, this investment will yield the same outcomes that have plagued the Qataris and Diamond since 2013 – further brutal losses to investors. The Qataris as it happens have already experienced a loss on Panmure Gordon: their 23 million GBP stake in Panmure made in 2009 is now worth only 9 million GBP. Without access to the secret formula for success that Diamond and the Qataris must believe they possess, it is difficult to understand why they would wish to offer a premium to acquire the rest of Panmure Gordon.
Until such time as these investments pan out, it is perhaps easier to understand them in the context of Kahneman and Tversky’s experiment. These are investments that are being made not within the context of a rational investment universe, but rather by market participants whose idiosyncrasies are impinging on rationality. And those idiosyncrasies, at least for the time being, are that they are in significant loss positions at present.