FEATURE: BEHAVIOURAL FINANCE
and ‘mental accounting’. particularly if the latter involves feelings
PROFILE – FACT BOX
Prospect theory centres on the of regret and loss.
diff erent attitudes to risk when investors Th ese two observations go a long
are either looking at profi ts or losses. way to explain some of the investment
Experiments have shown that investors decisions we see on a regular basis,
are risk averse when looking at profi ts, which often result in investors selling
but tend to be risk takers when winners too early and holding on to
confronted with losses. losers too long.
‘Mental accounting’ points out that It is a commonplace observation that
investors view each position within a the typical fund manager is an optimist
portfolio as an entirely separate item and who feels most comfortable when
treat them in an inconsistent manner. In looking for the opportunities that will
particular, investors tend to bucket do well. Th is tendency has a number of
‘winners’ and ‘losers’ separately and the observable consequences. It means that
chances of something being sold increases the majority of a fund manager’s energy
simply if they have made a ‘profi t’ on the and time is taken up researching the
investment. Consequently it is hardly ‘Next Big Th ing’ and that selling simply
surprising that potential winners are sold becomes a cash raising exercise.
too early and poor performers are retained Consequently, it is not surprising that
because they are showing a loss, the decision on what to sell becomes
infl uenced by behavioural factors rather
Malcolm Smith, ASIP
STATS.
than the fundamentals. Career highlights:
We have also noticed that good Malcolm Smith, ASIP, is head of research
PERCENTAGE OF TIME THE SALES OUT OR
sellers tend to be cynical, pessimistic at Inalytics. Previously he was global
UNDER PERFORMED PREVIOUS 12 MONTHS and always looking for the hidden
head of performance analysis at ABN
problem lurking behind the next corner. Amro Asset Management. Between 1994
As a result they don’t tend to ‘fi t’ and
and 1999 he worked for Rothschild Asset
Outperformed
Underperformed
hence there is not an abundance of
Management in various capacities. He
people with these skills, but they are
has a degree in natural sciences from
highly valuable members of any
Cambridge, and is an external examiner
investment team.
of masters degrees at London
We have investigated whether the
Metropolitan University.
majority of stocks being sold had in fact
been the winners or whether investors
were running the winners and weeding negatively by 94 basis points a year. Th is
out the losers. is evidence of the impact that poor
On examination of the client selling has on the performance of the
“The performance database we found that 57% of stocks portfolio.
that had been sold had outperformed Consistent with our views that fund
impact from poor
over the previous 12 months. Th is result managers tend to be better buyers than
certainly underlines that fund managers sellers we found that the buys added
selling decisions has
tend to sell their winners. value by 47 basis points.
Putting these statistics together, the
LOOKING FORWARD: performance impact from poor selling
been 47 basis points a
IMPACT ON PERFORMANCE decisions has been 47 basis points
Having found evidence supporting the greater than the benefi t created through
year greater than the
thesis of the Disposition Eff ect, we then good purchases.
examined what impact it has on Th e results confi rm the general
benefi t created through
performance. To do this we calculated hypothesis that managers have skill,
the impact of every transaction on but that it often fails to translate into
portfolio performance. superior performance because it is
good purchases”
We found that in aggregate the off set by a series of predictable and
stocks sold impacted performance observable shortcomings.
WWW.CFAUK.ORG PROFESSIONAL INVESTOR 29
28-2928-29 equities.indd 29equities.indd 29 27/11/0827/11/08 15:53:3215:53:32
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