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Behavioural finance curtails human foibles

This article is part of
Behavioural Investing - November 2013

In theory, investing should be a piece of cake – buy low and sell high. But in reality, investors often behave irrationally. This is where behavioural finance can help.

In the words of Berkshire Hathaway boss, Warren Buffet, behavioural finance investors aim to “profit from folly rather than participate in it”.

Candid Financial Advice adviser Justin Modray says: “Behavioural finance investors require a rigorous philosophy and process. This invariably means that quantitative analysis takes precedent over more conventional qualitative research. For example, the Artemis SmartGarp system uses a complex computer program to analyse a large number of variables… before churning out a list of potential ‘buys’.”

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The Artemis Global Growth, European Growth and Capital funds use this system. Philip Wolstencroft, lead manager of the latter two funds, says: “The idea is that we try to avoid the behavioural biases by collecting data.”

Strategies that have been implemented to avoid falling into behavioural traps, commonly include value, contrarian and momentum investing. Mr Buffett is the classic ‘value’ investor. For decades he has enjoyed massive success on the back of buying good companies for less than what he felt they were fundamentally worth.

Taking advantage of behavioural traits rather than going against them can be an uncomfortable journey but in the long run it has paid off for a number of managers. Outgoing Invesco Perpetual Income and High Income fund manager Neil Woodford famously shunned technology stocks during the dotcom boom at the turn of the century, a classic case of herding, and saw his funds fall down the league tables as he underperformed against his peers. However, when the bubble burst, he protected his investors from the severe losses that followed.

Alastair Mundy, manager of, among others, the Investec Global Situations fund, is well known for his contrarian approach, where he goes against market trends by buying unloved stocks, which he believes have been underestimated by others. Mr Mundy’s fund has enjoyed considerable success against its peers in the past five years, returning 99 per cent against an IMA Global sector average of 85 per cent, according to FE Analytics.

But there are times when momentum investing does not work. In August, within the UK mid-cap space, a lot of names that had done well this year, such as Taylor Wimpey, gave a lot of their year-to-date gains back.

Even for those who are not invested, behavioural traits can have serious implications. For example, while having cash on deposit may calm peoples’ worries, inflation is ensuring they are still losing money. Greg Davies, Barclays’ head of behavioural finance, asserts: “People are buying themselves the opportunity to sleep better at night but we estimate that over time… we would expect that to cost them on average 4-5 per cent a year, and more so recently.”

Philip Scott is a freelance journalist

BEHAVIOURAL INVESTING: WHAT THE EXPERTS SAY

“There are a number of different major characteristics surrounding behavioural investing but few managers use it as an outright strategy to pick stocks. However, successful managers will employ various techniques to avoid falling victim to behavioural investing.”