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Wednesday, April 09, 2014

Money Managers Have Feelings, Too

News summary by MFWire's editors

It appears that singer Morris Albert, whoa whoa whoa, was right.

According to a recent Bloomberg article, money managers sometimes get blindsided by emotions when making investment decisions.

According to writer Lewis Braham, individual investors, money managers, even behavioral finance consulting firms are sometimes  trapped in their emotions battling the love-hate relationship between the winning investments and their personal biases.

Since the financial crisis back in 2008, it has seemingly become common knowledge that investors often behave with no rationale. But, can money managers avoid making the mistakes of the investing masses? This the question the Bloomberg article raises.

First, let's look at the issue as it affects individual investors. “The endowment effect” has gotten the best of as many as 25% of professional investors, said  Michael Ervolini, CEO of behavioral finance consulting firm Cabot Research, in an interview with Bloomberg. Investors who become “emotionally invested in their winners” and are “reluctant to let it go even if there are good reasons to do so” are said to be loss aversion, the most common bias among individual investors, Cabot finds.

Although money managers may be more immune to loss aversion, as they have a greater incentives to get rid of the losing position for their best interest, they do seem to suffer from regret aversion. Regret aversion happens when managers are holding back on buying too much of a good investment in case they hit on the wrong bet.

Braham describes the situation in this way:
They establish a tiny position that allows them to pat themselves on the back if they’re right and avoid big regrets if they’re wrong. That's called regret aversion, and it occurs in one in six managers.
Biases cause errors, errors lead to loss. Then how do investors and money managers avoid biases? Dennis Ruhl, J.P. Morgan’s chief investment officer of U.S. Equity Behavioral Finance told Braham that his investment team has “peer reviews of their ideas by more objective team members.” Moreover, Ruhl lets quantitative models make the final decision, which “takes out the emotion out of difficult buy and sell decisions,” Ruhl said.

Quants are considered to have an advantage in the behavioral finance battles, but Braham writes that they can't escape it entirely.

On that subject Braham quotes Harin de Silva, president of Los Angeles quant shop Analytic Investors.

…every quant gets anchored to a few factors, such as the value or momentum effect. You can probably convince yourself there’s some economic or behavioral theory that makes them work. But in reality someone found them and we sort of backed into the explanation. It’s not like a law of physics.

Is this yet another perception that indexers will be able to exploit, and active managers, with their staffs of humans, have to address. Can active managers convince clients that PM feelings are, as Mr. Albert sang, "nothing more than feelings?"

And the debate over human investment management continues. 

Edited by: Ning Zhou

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