When emotions get in the way of our investments

Sam Slator 06/05/20 in Strategy

This time last year, Google searches were simpler and more optimistic, with people wondering ‘What is a Black Hole?” and ‘How many episodes in the Game of Thrones final series?’. This year, with the global pandemic, it’s more about ‘How to make a face mask’ and ‘How to file for unemployment’.

Having been inundated with bad news and scary statistics for a number of weeks now I, for one, have been searching for more positive vibes. Whether it’s about Captain Tom and his incredible fundraising efforts, companies doing good or just looking for simple science experiments for the kids to try, I’ve largely avoided any negativity.

Human nature and our investments

At the same time, I’ve found myself ‘anchoring’ and falling victim to ‘confirmation bias’.

Anchoring is when we fixate on one piece of information to the detriment of others – think ‘vaccines being tested’ rather than ‘vaccine still 12-18 months away’.

Confirmation bias is related to this. It’s when we form an opinion first and research second – filtering information selectively to back up our opinion: ‘Which companies are testing vaccines?’, for example.

Having found myself doing this with my daily browsing, it got me wondering how much influence my behaviour had had on my recent ISA and pension investments. Had my heart been ruling my head? Will my aggressive growth picks pay off in the end, or should I have been more conservative in my choices?

Time will tell. We all like to think we are considered, balanced and rational investors. In reality, though, most of us fall into at least a few common traps. So how can we help ourselves avoid them?

Five funds actively using behavioural finance

There are a number of funds whose managers actively use behavioural finance to avoid making some of these mistakes. Here is a selection of five Elite Rated examples.

M&G Episode Income

The investment process of this multi-asset fund has been designed specifically to prevent the manager falling victim to the very emotional biases he looks to exploit. The name “Episode” refers to those periods of time when investors’ emotions cause them to act irrationally. The manager uses behavioural finance to find pockets of value and invest against the herd, rather than following it.

He identifies three factors that can help to recognise a behavioural event. The first is too much focus on a single story – meaning when market participants draw their attention to a specific event and disregard other information. The second is where there are inconsistent responses – the market behaves differently from the manner suggested by economic developments. The third is any rapid price movement of any asset class, either up or downwards, which suggests an ill-considered response.

Jupiter UK Special Situations

The manager of this fund uses the concept of behavioural finance in his contrarian approach to investing. He firmly believes that by understanding the role that emotions play in managing money, such as overconfidence and anchoring, and that by reducing those emotions, he can gain an edge to avoid many of the pitfalls that befall active managers.

He also believes that frequent company meetings can introduce unintended risks as many CEOs emphasise the positive and downplay the negative and, in turn, fund managers tend to believe what they say to reinforce their own views on the company. To suppress this confirmatory bias from entering his portfolio, the manager limits his meetings with companies to occasions when there is a change of CEO as a new CEO typically gives more balanced information.

Lazard Global Equity Franchise

Run by a four-strong team, this fund is differentiated by the managers’ systematic approach to portfolio construction. Their automated construction process aims to remove the behavioural risks around stock ownership. Similarly, the construction of their investment universe without consideration to valuation means that their portfolio should only exhibit the risks they intend to take, and that they have not been swayed simply by stock bargains.

The resulting portfolio is made up of companies from all over the world, that have an edge in their respective business sectors.

Invesco Asian

The manager of this Asian equity fund has a very different approach and philosophy. He believes the behavioural error of mixing up good businesses with good investments can often lead to trouble, so he uses a very pragmatic and flexible strategy designed to separate these two elements.

As he says himself: “A share price is just the collective view of hundreds of human beings, who can often be unimaginative, over-emotional and too short-termist.”

Brown Advisory Global Leaders

This fund has a clear philosophy with a focus on businesses which deliver ‘exceptional customer outcomes’ – companies that are able to solve a problem that no one else can. The managers assess their own performance and mistakes, as well as having a third party consultant analyse their decision-making for behavioural errors, as part of their constant desire to improve.

Co-manager Mick Dillon says: “As keen sportsmen we believe that it is possible, with the aid of effective coaching and feedback, to continually improve as investors. Investment managers should have the same mindset as topflight tennis players and concert pianists – the belief that they can always get better.”

The views of the author and any people interviewed are their own and do not constitute financial advice. However the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Before you make any investment decision make sure you’re comfortable and fully understand the risks. If you invest in fund or trust make sure you know what specific risks they’re exposed to. Past performance is not a reliable guide to future returns. Remember all investments can fall in value as well as rise, so you could make a loss.