Fear factor – Why might value investors be less scared of certain stocks than the wider market?


Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

Here on The Value Perspective, we would never claim to be fearless – spiders, say, or the musical stylings of Michael Bublé can make us as uneasy as the next person. So why is it then that when investors are running screaming from a particular stock or sector, we are often to be found heading purposefully in the opposite direction?

The beginnings of an answer might be found in the work of US psychology professor Paul Slovic, who has spent his career studying how human beings appraise matters and make decisions – and especially how they perceive risk. Indeed, the paper that first brought him to prominence in 1987 was called Perception of risk.

His work has developed somewhat over the decades but this was where he came up with a framework to help explain why some people perceive some things to be much riskier than others even though a more dispassionate appraisal of the facts would suggest differently. Given the paper’s publication date – the year after the Chernobyl disaster – nuclear power features as a particular concern for people.

Slovic’s framework comprises a total of 18 factors so let’s apply a selection of them to an area of investment that is currently given many people the shivers and see why that might be so when, to our way of thinking, it looks much more enticing. The supermarket sector, with Tesco to the fore, seems a highly topical candidate.

Some of Slovic’s factors are less relevant than others – it seems unlikely, for example, that too many children will be put specifically at risk in the event of Tesco going bust – but others are pertinent. Right at the top of the list is ‘Catastrophe potential’ – effectively whether something bad could happen and to what degree – while another is whether the possibility of something happening inspires ‘Dread’.

In the case of supermarkets – and investment in general – the catastrophe potential is that you lose your money and there are plenty of studies that suggest people do dread that. Indeed, as we have noted in articles such as Emotional rollercoaster, the behavioural finance concept of ‘loss aversion’ indicates people feel the pain of loss far more acutely than they enjoy the pleasure of gain.

That ties in with Slovic’s factor ‘Accident history’ – in an investment context, whether there are any precedents for people losing money on supermarket shares. Obviously there are and, once again, because financial losses tend to stick in people’s minds more than their gains, investors may find it easier to recall those difficult instances from the past.

‘Controllability’ is another factor – can you personally control whether Tesco has good or bad results? Well, unless you are one of a tiny group of people, you do not stand a chance. Then there is ‘Victim identity’ – is the victim known to you? Yes – it is you. And how much ‘Media attention’ surrounds the issue? Over the last few months, presumably a great deal more than Tesco would have wished.

A seventh and final factor we will highlight is ‘Reversibility’ – are the effects irreversible? Well, if you lose money, it might not necessarily be but investors are often minded to think it will be very hard to recoup. Either way, a struggling stock would appear to tick a fair number of Slovic’s boxes and help explain why investors may see it as a much riskier prospect than a more cool-headed appraisal of the facts – exactly the kind of discipline a value framework seeks to impose – may suggest they should.


Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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