Fund manager over-confidence ‘leads to losses’

Fund manager over-confidence ‘leads to losses’

An investment veteran has warned that fund managers’ over-confidence will often lead to losses, as professional investors are divided about how to manage emotional biases.

Lee Freeman-Shor, fund manager at Old Mutual Global Investors, examined 1,866 investments between 2006 and 2013 and found the majority of investors’ “great ideas” actually lost money.

He said one of the big dangers is fund managers’ over-confidence in their ideas: “People shouldn’t be too confident in their ideas because that's when it tends to go wrong; you can’t be smarter than the markets.

Article continues after advert

“With professional investors, it’s a bit like driving a car where everyone thinks they’re better than average.”

Mr Freeman-Shor, who wrote a book on behavioural investing called the Art of Execution, said it’s what fund managers do when they are losing that really matters.

They either become ‘assassins’, where they cut out their losing stocks, ‘hunters’ where a falling stock might prompt them to double-up on their position, or ‘rabbits’ where they fail to take action.

“Even the best investors which have these natural habits of success will sometimes reach the point where they have lost enough money, but they won’t sell it because they are sure they are right.”

But the Old Mutual fund manager said he would fire a fund manager who had the ‘rabbit’ characteristics with no assassin or hunter attributes.

Mr Freeman-Shor said another bad trait, which he said is also common, is when investors take profits too early.

“Most people have price targets, which I think are a bad thing because – while these targets are based on models – they guarantee that you are never going to win big.”

His “good investors” trim their winners without selling out completely in case the stocks keep rising.

While the industry has become increasingly aware of behavioural finance and how emotions can alter investment decisions, Mr Freeman-Shor argued most people pay “lip service” to the concept.

Jeremy Lang, partner and fund manager at Ardevora Asset Management, said analysts and investors often make bad decisions when confronted with too much information, or react by learned behaviour instead of the “cold eye” of rational scrutiny. 

“We look for situations where people’s intuitions are likely to be focusing on the wrong kind of information."

He said company managers are prone to excessive ‘risk-taking’, and their “ego-centric” personality type and remuneration structures give them a skewed view of risk. 

“Instead of prudently developing their business, we believe company managers, driven by their over-confidence, are more likely to take too much risk and cause harm.”

Mr Lang said he selects companies based on situations where management is either constrained or where the business is too strong to break, while he also avoids meeting with managers so he can judge the firm by observable facts.