Social Proof
Pfäffikon SZ, Switzerland – If we were to cut the months of August and September from the year’s calendar then not a lot has happened. In this period investors have unnecessarily wound themselves up about all kinds of topics that they shouldn’t be worried about. In the meantime Abn Amro is preparing itself for its initial public offering. While beating their chests, the Dutch Ministry of Finance has reported that there exists a real possibility that the Dutch national treasure chest will pretty much not make a loss on the many billions in government bailouts expended during the financial crisis. I wouldn’t be so proud of that result.
Thoughts
I’ve shared with you before my thoughts on why Abn Amro’s public offering is not a good idea. Now that the IPO seems to be on the way many investors will be pandered into taking up the bank in their portfolios. The pressure around you will contribute to you possibly being swayed into signing up for Mr. Dijsselbloem’s IPO. This phenomenon is also called “social proof”. Social proof is the most dangerous form of proof that exists on the market.
Example
When for example large companies suddenly start investing in a particular sector, often a chain reaction takes place where other investors join in. Investors who – based on nothing – do not want to miss the boat. Some years ago we saw this with oil companies that were suddenly buying fertilizer business, but no one could provide a solid argument as to why. Ultimately this led to an absolute disaster. This phenomenon rears its head at the Tupperware party, but Herbalife also uses this so-called multi-level marketing formula. The catch is that this formula leverages social proof in a powerful way. After your buy-happy neighbor’s girlfriend raved about it you often go along, but in reality you don’t know why.
We can find social proof in all layers of society. Whether it’s the completely hyped-up real estate market in Amsterdam or Switzerland, or a stock without real intrinsic value, the masses, through the effects of social proof, will move towards dumb, unwise and extremely risky purchase decisions. That’s how it also works with an IPO. The most recent example is the Ferrari IPO. Fiat is basically in need of money and got the chance to bring Ferrari to the stock market at an inordinate price – smart move by Serio Machionne. Mr. Dijsselbloem has the same intentions with Abn Amro. I have explained to you before that yours truly will never participate in an IPO because it’s a rigged game.
No Bank
The Dutch investor Frederik van Beunigen recently stated that he never invests in banks, something I can understand very well. Befitting as it is for an experienced investor, Van Beunigen does not allow himself to be led by social proof, moreover he has additional well-founded arguments not to invest in banks. For whoever is interested, I recently came across a recent report against Oliver Wyman on the RoE (Return on Equity) values since the financial crisis. Research shows the financial sector lagging behind in terms of RoE. Banks in general, in terms of their returns, are comparable to ordinary power companies and are perhaps finding themselves in a death spiral. Moreover, I don’t get the impression all-mighty CEO of Abn Amro – Gerrit Zalm – can give a positive spin to all of this. The bank of the future is surrounded by a lot of change and uncertainty and in all likelihood will become a widely used platform that gets milked.
Don’t let yourself get carried away by social proof. Whether it’s the purchase of a house, consumer goods or a stock, always ask yourself whether you’re being sucked in by the masses. The only way to avoid this is by doing your own thorough research. Take my word for it – that’s not easily done. That’s why many fall into the trap of social proof.
It remains for me to wish you a good weekend.
Jan Dwarshuis is a senior asset manager at Thirteen Asset Management AG, where he is responsible for the Thirteen Diversified Fund. Dwarshuis writes his columns in a personal capacity and is not paid for them. Nor is he paying for his columns to be placed. Professionally, he holds positions in major European, American and Russian stock funds. The information in his columns is not intended as professional investment advice or a recommendation to make certain investments. At the time of writing, he has no position in the above mentioned shares and has no intention of doing so in the next 72 hours.
