Sunday, February 12, 2006

Seven Sins of Fund Management

This is an excellent discussion of behavioral finance and the follies to be avoided in investment.


Barry, at "The Big Picture" has provided this link to James Montier's compendium of behavioral financial advice.

The first "sin" as he describes it is listening to strategists, economists, and analysts. Ignoring others and utilizing your own common sense is a very valuable attribute in investing.

I have a great deal of empathy for analysts (especially being guilty by association...I am a CFA myself) and recognize the enormous pressure that exists to provide useful comment with every bit of incremental "news." There is tremendous pressure to come up with insightful and timely comment and to be the first on the "Street." Instant analysis tends to undermine thoughtful, quality analysis.

There are tremendous pressures from corporate managements, from investment bankers (at least fewer than pre-Sarbanes-Oxley) and from institutional holders of stocks that one follows. Maintaining an optimistic or bullish viewpoint is pretty general, rocking the boat is frowned upon or at least is difficult to accomplish, and non-consensus viewpoints can make one look pretty aggressive, if not stupid. The Buffetism about no individual lemming ever getting a bad rap is apropos here.

The pressure to conform is huge.

Unfortunately, conformity and consensus does not win as far as stock market performance. Consequently, all the biases that analysts tend to bring if not suffer, also tend to reduce a client's ability to excel.

One other issue in defence of analysts...your horizon may differ from theirs. The outlook over the near-term tends to be what analysts are paid for...not a five year outlook. I have always maintained the view that it is far easier for us to have a better perspective of long-term profitability rather than what the next quarter will look like. Yet analysts gravitate to the short-term forecast, much of Wall Street demands it, and most "investors" think that short-term earnings surprise is what matters.

The study of behavioral finance helps one appreciate the biases that one brings to the investment arena, and better yet, the biases that all market players may bring here. Though this article is quite lengthy, it is quite pertinent.

Go with your own thinking but be aware of your psychological biases and those of the marketplace. You can overcome both!


At 10:58 AM, Blogger NO DooDahs said...

"Unfortunately, conformity and consensus does not win as far as stock market performance." Yes, and unfortunately conformity and consensus-following are what allows a manager to rise to the top of managing most mutual funds. There *are* exceptions, but probably 8000 of the 8800 or so mutual funds are run "by the book."

This of course lends credence to the myth of EMH. "Fund managers consistently fail to beat the market, so the market *must be* efficient." BS! If you and I had to invest under the pressures that they do, we wouldn't beat the market, either.


Post a Comment

<< Home

< ? Market Blogs £ >