Feature – Investor psychology
good at analysing things that are below the surface,” he says. “The first order stuff people process but second order informa- tion people are not so good at processing.” People also seem to dislike ambiguity. Research by Antoniou has found that as analyst forecasts for smaller companies are relatively more ambiguous; they are priced pessimistically by investors wary of conflicting information.
While people may be superficial thinkers, their emotions seem to have powerful effects on their decision-making. A study by Antoniou compared the forecasts of analysts who were in close proximity to a terrorist attack with analysts who were else- where. The study showed that analysts in the attack zone pro- duced more negative predictions than their counterparts. The pessimistic effect lasted for about 30 days. The effect is stronger when the analyst is closer to the event and located in a low-crime region, he found. Affected analysts were also relatively more pessimistic around the one- and two- year anniversaries of the attacks. The findings indicated that exposure to extreme negative events affects the behaviour of information intermediaries and the information dissemina- tion process in financial markets.
Group think Humans are not especially solitary creatures; investing, like so many other activities, can be conducted in a collective as well as an individual capacity. Groups are psychologically important to humans and a place in which humans do much of their learning. Yet here again, institutional investors being a collec- tive will have the advantages – and disadvantages – of group psychology. Nicholson contends that groups are not good at making deci- sions because they can let their psychology overcome their rationality.
“If you look at groups like juries and the way they make deci- sions you will see that if they are disciplined, a group can be good because then you get more information in the room than any individual can have, you could avoid errors and be alert to things, but unfortunately that’s not how it goes,” he adds. There are a range of reasons people organise themselves into groups, including a desire for recognition and esteem. More altruistically, they also want to contribute to a common good. But when a person ventures an opinion in a group setting they may find it harder to row back from it and change their mind. “As soon as I say I prefer the red to the green and you say I agree, I’m stuck. It’s harder to retreat once you’ve got that group psychology working,” Nicholson says. He adds that a typical error made in groups is when people pat themselves on the back if they’ve made a decision efficiently, whereas speed and efficiency might not be good practices for groups, which may need more time to deliberate than they give
26 | portfolio institutional March 2020 | issue 91
themselves. “We congratulate ourselves often on efficiency cri- teria when actually we should be congratulating ourselves on effectiveness criteria,” he notes.
A common handicap from which groups may suffer, that of uniformity of thinking, can be directed by the uniformity of their make-up, with boards often being “stuffed full” of like- minded people, according to Nicholson. “There’s a not so distant history of company decision-making showing how so-called independent directors don’t do their job and are not so much of a canary in the mine, frankly, not blow- ing the whistle when they should. They want to be liked and valued and they’re being paid anyway so they want to help the company and helping means not making trouble,” he observes. Group chairs often want to be well liked and avuncular, Nichol- son says, whereas what is really needed is an effective chairper- son who will make sure contrarian voices are heard, presump- tions are challenged and not give anybody an easy ride. Although groups of individuals can in theory add up to more than the sum of their parts, with different and complementary strengths working together harmoniously the cognitive and emotional biases experienced by individuals can also be mag- nified in a group setting. Professor David de Meza points out that one of the weaknesses of investment groups is that understandably no one is willing to be the person identified as making an investment mistake. This makes for herd behaviour which leads to instability. “People think trends will continue, excessively buying things that have risen in the past and excessively selling things that have fallen in the past,” he says. “This exaggerates trends and can lead to dysfunction in the market.” Researchers speculate that if a person perceives themselves to be similar to those around them they may be more likely to agree with the other members of the group and less likely to challenge them. The antidote to such uniformity and herd like behaviour is diversity.
“What you really want is psychological diversity; you don’t want people who have the same history,” Nicholson remarks. Yet this inevitably poses a problem for asset managers, who tend to use similar recruitment methods and hence by accident or design, recruit people from similar backgrounds and with similar attributes.
“Do recruiters choose the same old kinds of people?” Nichol- son asks. “I think they do. The same sort of people apply and on it goes. Does that reinforce or continue the psychological biases in investment? I think so, yes. To have somebody differ- ent in the room who is going to challenge accepted wisdom is unlikely in some of these contexts.”
As behavioural economics moves into the mainstream the asset management industry has started to take notice. Fund
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