These are uncertain times for a UK portfolio manager. As Brexit negotiations rumble on, over a thousand days since the European Union referendum, it is perhaps easier than ever to focus on the parliamentary proceedings, headlines and tweets ahead of company fundamentals.
As humans we are subject to powerful emotional biases that can affect our decision making, often to the detriment of investment returns. Benjamin Graham said it this way in his famous book, The Intelligent Investor:
“Though business conditions may change, corporations and securities may change and financial institutions may change, human nature remains essentially the same. Thus the important and difficult part of sound investment, which hinges upon the investor’s own temperament and attitude, is not much affected by the passing years.”1
Understanding investor behaviour
The difficulty stems from the fact that humans are social beings and investing is inherently a social activity. As groups, we repeatedly veer to extremes in our optimism or pessimism, leaving mispriced securities in our wake. These behavioural biases are typically at their most extreme at times of stress, such as that facing UK investors today. During these stressful periods, it is more important than ever to have not just an understanding of these biases, but a strategy to deal with them.
One such bias worth exploring further is confirmation bias, which impacts how well we can integrate new information with prior beliefs. This bias manifests itself in a number of ways. First, we tend to seek information that confirms our belief and dismiss or discount information that disconfirms it.
Second, we generally interpret ambiguous information in a way that is consistent with our prior beliefs. Once we believe something, the mistakes we make often serve to preserve our view.2 Politicians also fall into this trap. From an investment perspective, it is essential to maintain an open mind and we think there is an edge to updating your beliefs better than others.
A particularly difficult bias to overcome is loss aversion. It’s also a bias that can have powerful effects on decision making. Behavioural economists and psychologists have observed that humans suffer losses roughly twice as much as they enjoy equivalent gains.3 That you should be twice as upset at losing £10 as you are happy at winning £10 is inconsistent with classical utility theory. We believe investors can generate an edge by making consistent decisions with regard to the opportunity set in front of them.
Exploiting behavioural biases
In the JPM UK Equity Growth fund we look for high quality companies which are exceeding expectations. This repeatable investment approach allows us to consistently identify genuine growth opportunities in the market.
Kyle Williams is a portfolio manager for the JPM UK Equity Growth Fund.
- Benjamin Graham, The Intelligent Investor: The Classic Text on Value Investing, Third Edition (New York: HarperBusiness, 2005)
- Chetan Dave and Katherine W. Wolfe, “On confirmation Bias and Deviation From Baysian Updating”, Working Paper, 21 March 2003
- Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Making Under Risk”, Econometrica, Vol 47, No 2, March 1979, 263-292 and John W. Payne, Suzanne B. Shu, Elizabeth C. Webb and Namika Shagara, “Development of an Individual Measure of Loss Aversion”, Association for Consumer Research, October 3, 2015
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