Mr Spock, Investment Manager
Improving Outcomes with Logic
Learning outcomes
- Learn about the common behavioural traits and biases that impact investment decision-making and diminish portfolio performance.
- Understand the fund lifecycle and how to spot indicators of imminent decline.
- Discover practical steps you can take to mitigate bias, simplify investment decision-making, and build a robust investment strategy for your clients.
Psychological DNA
In the same way a magnet affects iron filings, our psychological DNA drives much of our behaviour. We do not think about it consciously.
+ info
1.Common bias
Behavioural Heuristics
Common bias
Hot-hand fallacy
Regret aversion
Disposition effect
Confirmation bias
+ info
+ info
+ info
+ info
May I say that I have not thoroughly enjoyed serving with Humans? I find their illogical and foolish emotions a constant irritant.
Mr Spock, Day of the Dove - Star Trek: The Original Series (Season 3, Episode 7)
2.Fund lifecycles
Alpha Decay
Inconsistency
99%
Less than 1% of US Equity Fund Managers are consistently skilled and able to outperform their benchmark over a 36 year period
Data: John C. Bogle (2007) The Little Book of Common Sense Investing
active management suffers from cognitive bias
There's an ongoing debate about whether actively managed funds are worth the higher fees they charge...
+ info
Alpha decay
Thematic Alpha builds quickly...
slowly plateaus & then slides towards mediocrity...
before sharply mean reverting
Data: The Alpha Lifecycle, Essentia Analytics
Human cognitive bias
Logic, evidence & process
The 50th Percentile
The 75th Percentile
‘logic is the beginning of wisdom, not the end’ - Mr Spock, Star Trek VI: The Undiscovered Country
Dispassionate exit
Hypothetical performance had managers sold their positions at peak
Basis line representing performance of index
Average funds actual return through the full lifeycle
Data: The Glass Half Full, Essentia Analytics
3.Key indicators
How to spot imminent decline
Be objective
Rank each potential fund in a sector based on absolute percentiles relative to all others
"Insufficient facts always invite danger"
Use logic
To make better investment decisions, it is important to recognise inherent biases and remain objective. Rather than becoming emotionally attached to investments, having a clear plan for buying and selling can be helpful.
+ info
Be dispassionate
10%
Funds in the top decile are acceptable
10-20%
Funds in the 2nd decile are reviewed
20% +
Funds below 2nd decile are automatically sold
Don't speculate
Accepting some of the initial upside will be sacrificed
Objectively capture demonstrable alpha
Exit based on evidence over speculation
Data: The Alpha Lifecycle, Essentia Analytics
4.Mitigating bias
Practical steps to improve decision-making & logic
Be self aware
The BeFi Barometer survey asked IFA respondents to what extent they agree with statements that imply their own behavioural biases.
65%
82%
Overconfidence - 'I think my portfolio management skills can help clients outperform the market'
Loss aversion - 'tend to feel twice as bad about loss as I feel good about an equivilent gain'
51%
54%
Recency bias - 'I am influenced by recent news events or experiences when making investment decisions'
Confirmation bias - 'I seek information that confirms my perception or current views'
Data: Cerulli Associates, in partnership with Charles Schwab Investment Management, Inc., and the Investments & Wealth Institute
Mitigating bias
Hot-hand fallacy
Regret aversion
Disposition effect
Confirmation bias
+ info
+ info
+ info
+ info
Practical steps
Document & review
Scenario analysis
Peer review & challenge
Data-driven analysis
Outline the decision-making process for accountability and continual upgrade.
Evaluate resilience to market scenarios and stress test conditions for robustness.
Seek diverse perspectives to help identify blind spots and challenge existing assumptions.
Assess performance, risk & positioning objectively via quantitative data.
Conclusions
A multifactor model & broad data set can help to contextualise & identify early decline. Self-awareness prompts recognition of biases, fostering an openness to alternative views and rational decision-making.
We can employ practical steps to help;
There are many common behavioural traits and biases that impact investment decision-making and diminish portfolio performance. However, they can be mitigated and in some cases, leveraged.
- Be dispassionate
- Don't speculate
- Challenge your views
- Be self aware
'Humans do have an amazing capacity for believing what they choose and excluding that which is painful.' -Mr Spock, And the Children Shall Lead - Star Trek: The Original Series (Season 3, Episode 4)
Thank you!
The disposition effect
Making more objective decisions
Broad framing is the technique of trying to view our decisions in the scheme of the many financial decisions we make rather than in isolation. Much like the relative scoring mechanism across multiple sectors, with a strict rulebase.
- Contextualise individual decisions against peers
- Implement a strict evidence-based rule set
- Seek to detach emotion from all decisions
Assigns the highest relevance to a blend of ‘Core’ and ‘Responsive’ data, and gives the lowest relevance to ‘Defensive’ outputs.
Neutral
Defensive ratios are given the highest priority, followed by a blend of Core and Responsive data, with the least importance given to Core.
Defensive
OR
- Alpha
- Beta
- Positive Periods
- 1 month performance
- 3-month performance
- 6-month performance
- Sharpe
- Sortino
- Upside Capture
- Maximum Loss
- Volatility
- Maximum Drawdown
- Maximum Loss
- Volatility
- Maximum Drawdown
- Beta
- Positive Periods
- Sortino
- 1-month performance
- 3-month performance
- Sharpe
- 6-month performance
- Alpha
- Upside Capture
Our psychological DNA can be classified to help us understand our key Drivers / Archetypes and the sorts of bias we may be susceptible to
Scoring
Each Factor is scored from 1-100 relative to all other sector members
It's all relative
Reduce the noise
Ultimately, each factor will form part of an overall league table, driving an indication of upward or downward momentum. However, by making the scores relative to peers – it is possible to build context, oversight and isolate sector-specific trends.
By building a multifactor model in this way, you will take away big graphs, absolute data, individual spikes and create a 3-dimensional view
The disposition effect
refers to our tendency to prematurely sell assets that have made financial gains, while holding on to assets that are losing money. We are driven to sell our winning investments to ensure a profit but are averse to selling losing investments in hopes of turning them into gains.
Regret aversion
Regret aversion occurs when a decision is made to avoid regretting an alternative decision in the future. Regret can be a powerless and discomforting state where people sometimes make decisions to avoid this outcome.
The chart pictured (courtesy of the late John Bogle) shows that over 36 years, less than 1% of US equity fund managers (the red dots) are consistently skilled and able to outperform their benchmark
Confirmation bias
Occurs subconsciously
While it is therefore likely impossible to eliminate confirmation bias completely, these measures may help manage cognitive bias and make better decisions in light of it.
- Listen to your gut
- Diversify your data sources
- Engage in active debate
Alpha Beta Positive periods Sharpe Sortino Upside capture (3 year)
1 month 3 month 6 month Performance
Low volatility Max loss Low max drawdown (3 year)
Total Score
The addition of each ranked score, each with different weighting applied via a Scenario Modifier (Defensive or Neutral)
Regret aversion
A Buddhist approach
By learning to accept outcomes we can adjust our perspective towards them and seek to minimize the discomfort of regret. More practically we can;
- Implement rational decision frameworks
- Seek feedback
- Use data over intuition
- Manage stress & emotion
Confirmation bias
Confirmation bias describes our tendency to notice, focus on, and give greater credence to evidence that fits our existing beliefs. From an investment perspective, this overconfidence can result in a false sense that nothing is likely to go wrong, which increases the risk of being blindsided when something does
Hot-hand fallacy
The hot hand fallacy is the tendency to believe that someone successful in a task or activity is more likely to be successful again in further attempts. It is derived from the saying that athletes have “hot hands” when they repeatedly score, causing people to believe that they are on a streak and will continue to have successful outcomes..
Hot-hand fallacy
Luck, skill or something else?
To ensure that the hot hand fallacy does not override logical reasoning, we have to turn to larger sets of data when making evaluations of past performance and upcoming trends.
- Expand the underlying data set
- Adopt a multifactor approach
- Contextualise results against a wider peer group
Dr Spock
Paul Hogg
Created on March 13, 2024
Start designing with a free template
Discover more than 1500 professional designs like these:
View
Pastel Color Presentation
View
Visual Presentation
View
Relaxing Presentation
View
Modern Presentation
View
Colorful Presentation
View
Modular Structure Presentation
View
Chromatic Presentation
Explore all templates
Transcript
Mr Spock, Investment Manager
Improving Outcomes with Logic
Learning outcomes
Psychological DNA
In the same way a magnet affects iron filings, our psychological DNA drives much of our behaviour. We do not think about it consciously.
+ info
1.Common bias
Behavioural Heuristics
Common bias
Hot-hand fallacy
Regret aversion
Disposition effect
Confirmation bias
+ info
+ info
+ info
+ info
May I say that I have not thoroughly enjoyed serving with Humans? I find their illogical and foolish emotions a constant irritant.
Mr Spock, Day of the Dove - Star Trek: The Original Series (Season 3, Episode 7)
2.Fund lifecycles
Alpha Decay
Inconsistency
99%
Less than 1% of US Equity Fund Managers are consistently skilled and able to outperform their benchmark over a 36 year period
Data: John C. Bogle (2007) The Little Book of Common Sense Investing
active management suffers from cognitive bias
There's an ongoing debate about whether actively managed funds are worth the higher fees they charge...
+ info
Alpha decay
Thematic Alpha builds quickly...
slowly plateaus & then slides towards mediocrity...
before sharply mean reverting
Data: The Alpha Lifecycle, Essentia Analytics
Human cognitive bias
Logic, evidence & process
The 50th Percentile
The 75th Percentile
‘logic is the beginning of wisdom, not the end’ - Mr Spock, Star Trek VI: The Undiscovered Country
Dispassionate exit
Hypothetical performance had managers sold their positions at peak
Basis line representing performance of index
Average funds actual return through the full lifeycle
Data: The Glass Half Full, Essentia Analytics
3.Key indicators
How to spot imminent decline
Be objective
Rank each potential fund in a sector based on absolute percentiles relative to all others
"Insufficient facts always invite danger"
Use logic
To make better investment decisions, it is important to recognise inherent biases and remain objective. Rather than becoming emotionally attached to investments, having a clear plan for buying and selling can be helpful.
+ info
Be dispassionate
10%
Funds in the top decile are acceptable
10-20%
Funds in the 2nd decile are reviewed
20% +
Funds below 2nd decile are automatically sold
Don't speculate
Accepting some of the initial upside will be sacrificed
Objectively capture demonstrable alpha
Exit based on evidence over speculation
Data: The Alpha Lifecycle, Essentia Analytics
4.Mitigating bias
Practical steps to improve decision-making & logic
Be self aware
The BeFi Barometer survey asked IFA respondents to what extent they agree with statements that imply their own behavioural biases.
65%
82%
Overconfidence - 'I think my portfolio management skills can help clients outperform the market'
Loss aversion - 'tend to feel twice as bad about loss as I feel good about an equivilent gain'
51%
54%
Recency bias - 'I am influenced by recent news events or experiences when making investment decisions'
Confirmation bias - 'I seek information that confirms my perception or current views'
Data: Cerulli Associates, in partnership with Charles Schwab Investment Management, Inc., and the Investments & Wealth Institute
Mitigating bias
Hot-hand fallacy
Regret aversion
Disposition effect
Confirmation bias
+ info
+ info
+ info
+ info
Practical steps
Document & review
Scenario analysis
Peer review & challenge
Data-driven analysis
Outline the decision-making process for accountability and continual upgrade.
Evaluate resilience to market scenarios and stress test conditions for robustness.
Seek diverse perspectives to help identify blind spots and challenge existing assumptions.
Assess performance, risk & positioning objectively via quantitative data.
Conclusions
A multifactor model & broad data set can help to contextualise & identify early decline. Self-awareness prompts recognition of biases, fostering an openness to alternative views and rational decision-making.
We can employ practical steps to help;
There are many common behavioural traits and biases that impact investment decision-making and diminish portfolio performance. However, they can be mitigated and in some cases, leveraged.
'Humans do have an amazing capacity for believing what they choose and excluding that which is painful.' -Mr Spock, And the Children Shall Lead - Star Trek: The Original Series (Season 3, Episode 4)
Thank you!
The disposition effect
Making more objective decisions
Broad framing is the technique of trying to view our decisions in the scheme of the many financial decisions we make rather than in isolation. Much like the relative scoring mechanism across multiple sectors, with a strict rulebase.
Assigns the highest relevance to a blend of ‘Core’ and ‘Responsive’ data, and gives the lowest relevance to ‘Defensive’ outputs.
Neutral
Defensive ratios are given the highest priority, followed by a blend of Core and Responsive data, with the least importance given to Core.
Defensive
OR
Our psychological DNA can be classified to help us understand our key Drivers / Archetypes and the sorts of bias we may be susceptible to
Scoring
Each Factor is scored from 1-100 relative to all other sector members
It's all relative
Reduce the noise
Ultimately, each factor will form part of an overall league table, driving an indication of upward or downward momentum. However, by making the scores relative to peers – it is possible to build context, oversight and isolate sector-specific trends. By building a multifactor model in this way, you will take away big graphs, absolute data, individual spikes and create a 3-dimensional view
The disposition effect
refers to our tendency to prematurely sell assets that have made financial gains, while holding on to assets that are losing money. We are driven to sell our winning investments to ensure a profit but are averse to selling losing investments in hopes of turning them into gains.
Regret aversion
Regret aversion occurs when a decision is made to avoid regretting an alternative decision in the future. Regret can be a powerless and discomforting state where people sometimes make decisions to avoid this outcome.
The chart pictured (courtesy of the late John Bogle) shows that over 36 years, less than 1% of US equity fund managers (the red dots) are consistently skilled and able to outperform their benchmark
Confirmation bias
Occurs subconsciously
While it is therefore likely impossible to eliminate confirmation bias completely, these measures may help manage cognitive bias and make better decisions in light of it.
Alpha Beta Positive periods Sharpe Sortino Upside capture (3 year)
1 month 3 month 6 month Performance
Low volatility Max loss Low max drawdown (3 year)
Total Score
The addition of each ranked score, each with different weighting applied via a Scenario Modifier (Defensive or Neutral)
Regret aversion
A Buddhist approach
By learning to accept outcomes we can adjust our perspective towards them and seek to minimize the discomfort of regret. More practically we can;
Confirmation bias
Confirmation bias describes our tendency to notice, focus on, and give greater credence to evidence that fits our existing beliefs. From an investment perspective, this overconfidence can result in a false sense that nothing is likely to go wrong, which increases the risk of being blindsided when something does
Hot-hand fallacy
The hot hand fallacy is the tendency to believe that someone successful in a task or activity is more likely to be successful again in further attempts. It is derived from the saying that athletes have “hot hands” when they repeatedly score, causing people to believe that they are on a streak and will continue to have successful outcomes..
Hot-hand fallacy
Luck, skill or something else?
To ensure that the hot hand fallacy does not override logical reasoning, we have to turn to larger sets of data when making evaluations of past performance and upcoming trends.