More than Behavioural Investing
Posted on January 23, 2008 by Richard Beddard
Filed Under Investing |
It was over three months ago that James Montier’s new (well it was then) book arrived at Interactive HQ and I received it with high expectations. Amazingly, it’s met them.
I started reading Behavioural Investing straight away, and I’ve read a couple of chapters every lunchtime since. In fact, I’ll forever associate it with Pret a Manger, its delicious Swedish meatball ragu hot wraps, and an underground movement in the office to re-brand iBall as meatBall.
The duration of the interval is, therefore, in direct proportion to the length of the book and the fact that I wanted to read every word.
But before the eulogy, the gremlins, the minor irritations that do not prevent BI from being a comprehensive “practitioner’s guide to behavioural finance” as the publisher would have us believe, or a “guide to investing”, pure and simple.
Gremlin 1: It’s a collection of articles previously published in Global Equity Strategy. Some repetition is unavoidable, some of the articles feel a bit dated, but most annoyingly the references refer to the magazine, and not the book.
Gremlin 2. Mr Montier wrote it for institutional investors. Although it seems they speak much the same language as private investors, as the book made sense to me. It’s not an introduction to investing, though. It’s more a book to take you to the next level.
The premise of BI is that our brains work against us in investing. Far from being logical, calculating decision makers, we’re flighty emotional bandwagon chasers. Actually not us (it’s for institutional investors, remember) but fund managers, although one can assume most of us, private and those residing in institutions, are human.
If I’d bought every new book peddling this line, I’d be eating Swedish meatballs for the rest of my life (not that I’d mind). Mr Montier’s book goes way beyond the behavioural though, and in demonstrating the efficacy of strategies that circumvent the emotions he presents a survey of investing.
Not surprisingly, he favours strategies that cut out noise, the stories and hype that drive prices to unjustifiable highs, and emphasises contrarian styles like value investing and quantitave analysis. Value investing has been with us at least since Benjamin Graham practiced it between the Wars, so it’s not a new idea either.
In fact James Montier quotes Benjamin Graham, John Maynard Keynes and even Sherlock Holmes at length, which might seem odd for a book containing so much recent research. But the point is they were right. Mr Montier employs statistics on a scale they couldn’t have imagined to show it, and developments in the field of psychology to explain why.
Perhaps the biggest service he’s done for private investors, though, is in demonstrating that the City, and many of those managers who’d run your investments for you, are hamstrung by their own risk management and marketing departments.
They’re forced into taking the short-term view and selling investments that are going down (i.e. getting cheaper) and buying investments that are going up (i.e. getting more expensive) for fear of upsetting their customers (financial advisers, pension fund trustees). Ultimately, the tail, uninformed investors driven by emotion, is wagging the dog (professional investors who ought to know better).
The fact that Keynes already pointed this out, doesn’t mean that Montier deserves no credit for telling us it’s still true. Both affirm that despite all the technical wizardry and brilliant brains, the City labours under a psychological handicap. Advantage the intelligent and unshackled private investor, I reckon.
The sad thing is most private investors won’t get the message because the book is big, expensive, academic looking and not marketed at us. It isn’t intimidating once you start reading it, though, and despite a cover price of £60, it’s half price at certain online retailers.
Another sad thing: Mr Montier has shut down his blog and is limiting his output to his institutional chums. For now, you can still read the archived posts, and many of his articles are on the Internet. Just Google “Global Equity Strategy” and “James Montier”.
I recommend the book unreservedly. I’d like to review every chapter (there are 54). It’s more nourishing, intellectually, than a Swedish meatball, biologically, and that’s saying something. My only concern is that, in spending so much time on Behavioural Investing, I might have fallen for the oldest psychological blooper in the book; seeking out information that I agree with, and avoiding information that challenges my beliefs.
That, as Mr Montier explains, is a path to mediocrity.
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6 Responses to “More than Behavioural Investing”
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Hi Richard,
That is a concise review of the book!
I agree with you that a key message of the book is showing how professional investors suffer from all the same failings as the rest of us.
I think, however, that there is a gradual but inexorable shift away from simple CAPM type funds to more interesting varieties (such as fundamental indexes, long/short funds and hedge funds).
It never ceases to amaze me, in recent times, how hedge funds are criticised for losing a few percent during very difficult times and yet normal, long-only funds are regarded as performing okay if they lose a much greater amount over the same period, so long as they match their index.
I have actually come around to the view that the market is driven primarily by bad news (perhaps it is just a sign of the recent times
). If there is bad news, the markets go down … fast. If there is no bad news then the markets go back up slowly. I think also that bad news is additive, but only if it is delivered in small doses and not a single whack. I wonder if the market would be down quite so much after 3 to 6 months, if everyone could have anticipated all the knock on effects of the credit crunch in one go, instead of discovering the next bad thing at one monthly intervals.
I am currently sitting on 20% cash, not because my computer program is telling me to do it, but because I expect another blow to the market some time soon. If not then I have some money to invest if necessary.
Hi Robin. Yes it is (concise!). The book deserves more, but I was afraid that once I opened the floodgates and discussed his individual findings, I might be swept away and end up writing a summary of the whole book :-).
I like the way you relate the market to news. You may have noticed that I’m not spending much time writing (or thinking) about the stock market in general at the moment. That was always my way as an investor, but I’m writing more about companies these days too and, I suppose, I’m afraid I might be swept away by the floods of drivel written about the markets!
Re hedge funds though. Some of that criticism is justified isn’t it? After all they target absolute returns (which means losses aren’t really acceptable) while unit trusts etc. target benchmarks, which go down as well as up.
Hi Richard,
I have noticed that you have started to focus on individual companies this year. That is great. I found your article on “French Connection” very interesting.
The concept of ‘absolute returns’ is nonsensical really. There is no period over which you can guarantee this other than over a whole stock market cycle in which case you may as well invest in a long only index tracker.
However I like the idea of absolute returns and hedge funds because it suggests the practitioners are at least trying to utilise some more interesting investment techniques and are trying to limit losses at any one moment in time.
In the case of hedge funds, as these are unregulated, I would only invest in them through a well diversified fund of hedge funds. There are no guarantees they can provide which would actually protect you in the event that they ‘did a Jerome’ and went bust
Nice write up Richard - I had stumbled across the blog about 45 mins after JM’s. It’s an interesting area that relates to some analytics I’m performig currently for my org. I think the issue of momentum, not in the stock sense but the investor sense is very interesting, ditto dogs, tails, wagging etc.
I’m not an academic but a former buyer and fund analyst for many yrs so I tend to look at bottom-lines more than hypotheticals. Can I translate any index-based scenario to the returns of a Fund, not really. Can I use regression or attribution - yes but it simply tells me what the market model has pre-determined.
I now view the ‘investor’ (i.e. sentiment) as one of the most important risk metrics and the continual phase of overreaction and underrreaction to influences, events and opinion. Quantifying to track is the tricky bit but I increasingly believe that rather than being a passenger the investor is very much an active contributor, unwittingly or not.
I ran a cross-analysis last June for a US equity product and cross-correlated US/NA equity with global and European long equity funds.. a sample of some 6500 mutual funds (ex US dom)- this followed on from a seminar by MSCI Barra on falling cross-sector volatilities. I was able to replicate the bottoming trend via tracking errors - the results showed intense correlation (95-100% R2, t-stat ok, std error ok-ish) and spiralling into US super-caps as they reeled from some negative news in EM in Q3 06. This pattern again gathered pace as sub-prime was first properly muted back in March 07. It was a very tough period on any contrarian value managers (I can now better see why that happened).
Concur with you and Robin about the investor and news - what I am in the process of doing is building a multi-factor model of the investor risk premium by using large sales patterns as proxy then back-testing against actual downside (I’m using semi-dev to avoid any capm or other relative distortion). I want to trace contagion, risk and herding through these patterns, not withstanding any control from platforms, banks etc.
I have no pre-determined outcome per se, the model should prove one of historical hindsight but in some sort of newtonian sense risk is ever present and only changes in volume through money supply and really is constant and rather tarnsfers from passive to active risk (after any inertia)and back again. This hinges on investor reacton to what they see and hear around them and sell/buy accordingly. This as we have seen can be a catalyst for a sell-off.. in effect the investor is the physical embodiment of risk. The risk premium tracks their perception and the margin to the actual corresponding asset risk a gauge of market(i.e. lag/knee-jerk)inefficiency. There may be some patterns to observe but that in itself could be a mistake.
I’m not going to try and hook too much on hedge managers or private equity - yes they can distort and manipulate but the leverage vs. the sheer volume in non-hedge is more interesting to me. I see their effect as neutral as private equity is outside of my liquidity model and hedge I presume to have a neutral or opposing position to negate. I keep an eye on the volumes in play however.
As such as I have stepped back from market indices altogether (I see them priced into mutual universes already so avoid trying to mess about with what’s beta and what’s alpha) and now use mutual fund samples of proxy up to 50K funds cross-border, instl and retail..
it’s an interesting area I’m just scratching the surface on. I was at a seminar with Dr Gabriel Bernstein last year (Reuters) and he also questioned all recent MPT.. we had a nice debate on alpha vs. time that wasn’t too far off current research on alpha-degradation.
However latest markets show me much of what we micro-analyse isn’t really what counts in mutual markets, it’s what the ‘money’ thinks, the investor and it’s unpredictable nature.
Welcome any discussion
Jon
(A fund analyst/product manager working for an anonymous US bank)
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