Investment risk preferences of decision makers acting on behalf of German charitable trusts

Abstract

This research programme investigates the subjective utility of monetary outcomes and applies the existing knowledge base regarding the quantification and description of risk preferences to German charitable trusts. Results are discussed on the basis of Expected Utility Theory (EUT) and Prospect Theory (PT) with a focus on the “Fourfold Pattern (4FP)” of PT. The description of risk preferences of trusts enables investors, advisors and portfolio managers to optimise their investment strategies for this specific target group disposing of an estimated asset base of about € 100bn. The subjects of this study, German charitable trusts, are restricted in their investment decisions by a given legal framework and therefore prone to deviate in their preferences from the subjects that have been examined in prior academic studies. The thesis aims at filling this research gap by applying the knowledge base of decision theory to German charitable trusts using an original set of representative data which was generated as part of this study. Firstly, regarding the general investment risk preferences of trusts, the study finds risk aversion predominating in the domain of gains and observes loss aversion, both analogous to prior research on private individuals. The PT pattern of risk-seeking behaviour for losses can only partly be asserted. In contrast to PT, no evidence is found for the subjective overweighting of small probabilities. Secondly, the study identifies and discusses characteristics of trusts which are associated with risk preferences: Equity investments, expected external growth of assets, age of the investment decision makers, type of donor and involvement of the donor in investment decisions.As a contribution to decision theory, the author proposes a utility function representing the preferences of trusts based on decision theoretical backgrounds. As a contribution to practical investment implications, the author proposes to redefine the question of “safe investments” and to focus on distributable yields generated by a higher equity portion in trust portfolios.