There are unending debates about whether value offers more than growth, with Warren Buffett being held up as an example for both approaches. But while there are a handful of well-known managers that promote a specific style of investing, it is clear no one approach is the investment silver bullet that is able to deliver consistently strong returns across all market conditions.

Instead, the key is to understand both the benefits and limitations of the different investment styles and create a portfolio that takes advantage of the best of each approach.

The idea of behavioural investing or economics is using the understanding of different styles and investor biases to exploit the perceived ‘weaknesses’ of human decision-making. The aim of removing investor bias can also be considered one of the drivers behind the rise of quantitative-based strategies that use computers to do a lot of the underlying analysis for portfolio creation.

Ian Heslop, manager of the Old Mutual Global Equity Absolute Return fund, which uses a quantitative approach, points out the main difference between a quant and non-quant strategy is being “dispassionate” when buying and selling holdings, as emotion can get in the way.

There are many examples of individuals and asset management companies adopting a specific behavioural finance process, with the likes of Ardevora, Liontrust and JPMorgan Asset Management (JPMAM) springing to mind.

Controlling emotions

In a recent speech Michael Barakos, chief investment officer for European equities at JPMAM and author of its behavioural finance process, notes that “controlling our emotions such as anxiety, especially around high-pressure, volatile events, is crucial in generating and sustaining consistent investment returns”.

He added: “We’re not perfect, we’re human and humans make mistakes due to behavioural biases ranging from overconfidence to loss aversion. By being self-aware of our behavioural biases that arise due to our emotions and our personalities and by employing a fundamentally inspired, empirically proven decision-making process, we stand a much better chance of being self-controlled and hence successful in selecting investments.”

One of the common phrases often heard in investment is the term ‘following the herd’, essentially meaning those that jump on a popular investment trend or theme, whether they believe in it or not and even if it may be well past its peak in terms of returns.

One of the arguments for this is that if everyone is doing the same thing and it turns out to be wrong, then at least everyone is in the same boat. This then leads to those who call themselves ‘contrarian’ investors, who deliberately look to go against the herd. Yet they too could be overlooking promising investments simply because someone else got there first.

Investor bias is a complicated issue, with books and academic journals constantly highlighting the pros and cons and reasoning behind different approaches. But for the less skilled investor, simply realising that their emotions and reactions can influence their decision-making means they are perhaps more likely to understand it than others.

As Mr Barakos noted in his speech: “Your investment edge over the next decade or so won’t come from the knowledge anymore per se, it will come from how you analyse the information and how much you’re willing to learn and adapt to continuously improve your decision-making process.”

Nyree Stewart is features editor at Investment Adviser

COMMON TERMS

Herding

The concept that humans feel safer in a crowd rather than standing out and being different from everyone else.

Loss aversion and regret aversion

Biases that can lead to momentum anomalies seen in the market. The underlying reason being that few people enjoy saying, “I was wrong.”

Overconfidence

When investors believe they are better than everyone else at picking stocks, funds or investment themes. It can often lead to more frequent trading.