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Herd Mentality

4 May 2021

 

Investors probably don’t like to admit it, but their investment decisions are often influenced by what other people are doing. This is often true whether you manage your own investment portfolio or hand over responsibilities to a portfolio manager.

Herd Mentality

In behavioral finance, the tendency to follow and copy what other investors are doing is called herd mentality. This bias, which is largely based on emotion and instinct, replaces independent analysis with “heuristic simplification,” or cognitive shortcuts that simplify decisions during periods of uncertainty. Although herd mentality can lead to strong performance in the short term, this behavioral bias is at the cornerstone of major asset bubbles and market crashes that result from panic buying and panic selling, respectively.

Investors who observe the stock market’s performance in 2021 would hardly realize that the global economy is facing a multiyear economic downturn. Stock prices reflect unprecedented monetary and fiscal intervention from global governments, as well as hopes for a swift economic recovery post-COVID. However, these markets have yet to price in the dramatic consequences of growing central bank balance sheets and rising public deficits.  Even government bonds, whose yields have fallen precipitously over the years, continue to attract investor inflows despite offering minimal returns.

Despite the overwhelming prevalence of herd mentality in equity markets, a growing number of contrarian investors are turning to alternative assets to diversify their portfolios. For many investors, private mortgages represent an untapped segment of the alternative asset market that could significantly bolster risk-adjusted returns. Private lenders account for over 10% of some mortgage markets such as the Greater Toronto Area—a figure that highlights the demand for alternative lending options continues to grow. [Data source: Bank of Canada Financial System Review – 2019]

In addition to going against the herd, investing in private mortgages provides alternatives to zero-bound interest rates and inflated asset prices that typically characterize today’s public markets. In practice, private mortgages are considered defensive cash flow investments that are secured by real estate. As short duration fixed-income investments, private mortgages are highly sought after in Canada because they typically generate yields that are considerably higher than other fixed-income assets.

Investing in private mortgages usually takes on two forms—through whole loans that give investors more direct control over their portfolios or through a registered Mortgage Investment Corporation, which pools investors’ capital and diversifies across a portfolio of mortgages on their behalf. Both avenues seek exposure to the real estate market by providing direct loans to borrowers in need of mortgage financing. In exchange, investors receive interest payments and other fees charged to the borrower. Both investment options are uncorrelated with public markets.

Since inception, CMI Financial Group has successfully funded over $600 million in private mortgages across Canada. CMI provides residential mortgage investment opportunities through its CMI Mortgage Investments division, including its whole mortgage investment program and Family of MIC Funds, offering investors multiple options for diversifying their portfolios.

Herd Mentality

Investors interested in exploring their options in private mortgages are encouraged to learn about CMI’s mortgage investment process and contact one of our Investment Account Managers below for a free consultation.

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