Investor psychology – Feature


are made and vigilance profiles should be built in against those biases, he insists.


On the trading floor you have to train traders how to lose money because otherwise they start making bad decisions and won’t take the right risks. Professor Nigel Nicholson, London Business School


In group investment decision-making, people should be told at the beginning to park their previous positions and be open- minded; value people who change their minds, Nicholson stresses. The person who should be congratulated is the per- son who shifted their position the most in light of the evidence collected by others in the room. “You need to use the group to your advantage by using a dynamic that allows people to learn and not get anchored on their positions,” Nicholson says. He adds that in order to correct for herd behaviour, asset man- agers should build a culture around investment that involves rational scrutiny and doesn’t over-value the individual stars. Cognisance of the pitfalls of psychology on investment deci- sion-making could explain an apparent scepticism among researchers about the skills of asset managers, especially those deploying active investment strategies. Does active manage- ment of investment portfolios make any difference to returns or is it no more effective than, say, basing decisions on the movement of the stars in the firmament? Antoniou says the evidence is equivocal.


managers have an obvious interest in discerning whether the market is mispricing things so they can better identity the prize assets for which they search. The insights of behavioural ideas are relevant to what they do, hence an increasing number of fund managers have behavioural teams tasked with measur- ing and helping to iron out their biases. Part of the problem which the asset management industry needs to grapple with is that humans must work at being rational. Experts say that in our natural environment humans are not good at probabilistic thinking. Rather we are much better at categorical thinking: we like saying whether things are good or bad and making quick decisions.


If there are significant conditions of uncertainty, we congratu- late ourselves to build up our confidence so we can go into bat- tle and take risks. The psychology we have is one that suits us well to a hunter gatherer lifestyle but less so to a modern investment lifestyle. Nicholson recommends that for institutional investors and asset managers to turn themselves into dispassionate, evi- dence-based machines, training in behavioural and personality psychology should be standard in asset management. The point of the training would be to give the individual a more complex view of the world and how decisions are made. People should be taught how decisions are made, how bad decisions


“The evidence is that on average actively managed funds do not outperform enough to cover their fees,” he adds. “But there are papers which show there are skills in certain situations between some funds and some conditions. It is an active area of research and it is a debatable idea, so there is evidence on both sides as to whether they add value or not.” Tellingly perhaps, Antoniou does not put his personal invest- ments into actively managed funds. He is not convinced that they add value and thinks investing in passively managed vehi- cles like exchange-traded funds and market tracking products are a better option.


The mystique of asset management may crumble as the assault on its hitherto hidden psychological biases behind investment decision making are increasingly being revealed. Nicholson admits that he is cynical about the way people make judgements and decisions in financial services and feels that asset managers are too inclined to congratulate themselves for successes that may not be wholly attributable to their invest- ment abilities. “Asset management is an industry that is just floating on inflated values; asset managers sit around congrat- ulating themselves on good decisions when random stock- picking would work just as well,” he adds. One point is clear. An investor’s psyche plays a role in their decision-making and may be more influential than anything they have learnt in a lecture hall. Self-awareness and manging their impulses when faced with a decision are skills that could mean the difference between a successful investment strategy or not.


Issue 91 | March 2020 | portfolio institutional | 27


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