Feature – Investor psychology
In 1879, celebrated American artist William Holbrook Beard painted what would be his most enduring work, The Bulls and Bears in the Market. The painting depicted a mêlée between bulls and bears outside the New York Stock Exchange. In lavish oils, the throng of quadrupeds are shown in a heated outdoor clash. Some bulls are in full-throated cry and others are in determined charge; a huddle of bears appears to be in urgent conference while another has been hurled skywards. The scene is full of furious movement in contrast to the serenity of the handsome Grecian buildings surrounding it. The work helped to lay the foundation of the enduring mythos of the investor and their psyche. The words bullish and bearish entered the lexicon as adjectives describing the stereotypical characteristics of investors and markets, bullish investors charging together in testosterone fuelled excitement as mar- kets rise, bearish ones move with pessimistic caution as mar- ket curves swoop downwards. Yet that which was once the domain of art and cinema, with films like Wall Street embedding the image of aggressive brag- garts
riding market waves in public consciousness, has
increasingly become subjected to the quantitative analysis of social scientists. Behavioural economics has now gone main- stream, with Richard Thaler the latest to win a Nobel Memorial Prize for his work on the subject. The mysteries of the inves- tor’s psyche are gradually being revealed.
Irrational thinking
One of the first comforting myths about investment to fall to the unforgiving examinations of social scientists is that it is a discipline conducted on a rational basis. The truth is very dif- ferent; investment decision-making is riddled with cognitive and behavioural biases.
“There are systematic biases in investor behaviour,” Professor David de Meza of the London School of Economics says, not- ing that men are more likely to be active in buying and selling stocks than women. Some of the most important of the string of biases to which researchers say investors are prone include confirmation bias, in which facts may be subconsciously picked or emphasised to fit a pre-existing conclusion, and the endowment effect, in which people tend to believe that things they hold are valuable, leading to an overvaluing of investments. There are also illu- sions of control and hindsight biases in which people find themselves wise after an event. This fits in neatly with confir- mation bias and means that people tend to remember their successes but forget their failures, thereby reinforcing their preferences.
It could be tempting to downplay or dismiss the role of psycho- logical biases among investors, as of marginal significance in the grand scheme of things but there is agreement by industry
24 | portfolio institutional March 2020 | issue 91
What you really want is psychological diversity; you don’t want people who have the same history. Professor Nigel Nicholson, London Business School
participants and academics alike that cognitive biases can cause asset managers to lose money. Charles Cresteil, investment specialist at BNP Paribas Asset Management, cites biases and irrationality by investors as one of the reasons for inefficiencies in the market. In particular, he highlights short-termism and lack of portfolio diversification as irrational behaviours militating against investment success. “It is difficult to avoid your biases even if you are aware of them, Cresteil says, adding: “It’s what I call the escalator effect. When you see an escalator which is out of order, even if you prepare your brain to the fact it won’t work, after your first step on it your brain is always ready for it to move.” He stresses that investors should be aware of their biases as a first step and then they can find the tools to help them get around and possibly even benefit from their cognitive biases. The overconfidence of investors is a bias to which behavioural economists and psychologists return time and again. Think of the blind, charging conceit of a raging bull, impervious to the wiser counsel of more timid creatures urging it to slow down and think again. It might be a snapshot of the emotions and behaviours displayed in the market. Constantinos Antoniou, associate professor of finance & behavioural science at Warwick Business School, explains how overconfidence can be manifested in investment decision- making. “People either just trade too much or respond to news
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