Investor psychology does matter

PHIL Fortuna is the managing director of the quantitative group for Scudder Kemper Investments, one of the largest fund managers in the world.

Normally, when any one mentions the ‘quant people’ the eyes of advisers tend to glaze over. That is because so-called ‘quant people’ have a reputation for being terribly dreary and with personalities to rival accountants and actuaries.

Mr Phil Fortuna is an exception. In a presentation organised by the Zurich group here in Perth, he entertained his audience with aplomb and detailed analysis.

The basic premise of his presentation was that ordinary people have a limited processing ability that makes them poor investors. Mr Fortuna contends that investment clubs have an even worse track record.

As he put it: “bad investments happen to good people, so the people you advise need good information because they are terrible information processors”.

Fortuna bases his assertions on a study by University of California researchers, Odean and Barber, titled The Common Stock Investment Performance of Individual Investors and Too many cooks spoil the profits: the performance of investment clubs.

The study was the most voluminous and comprehensive in recent times. It involved the brokerage accounts of 66,000 households with stockholdings of $4.5billion over the period from 1991 to 1997. The investors had undertaken over $12 billion of trade over the period. The study also examined 166 investment clubs over the same period.

The average investor was able to achieve a return, annualised, of 16.4 per cent. The average investment club was able to return 14.1 per cent over the same period. The market over that period returned 17.8 per cent.

The study showed that the average household skewed their investment portfolio to volatile, small capitalisation stocks and turned over 80 per cent of their stock annually. Interestingly, the study also found that the average household would have had a better return over that period if they had left their portfolios alone and not bothered to trade at all.

Fortuna postulates that the reasons for this are that human beings have:

• Selective perception – seeing only what is in front of us and missing every thing peripheral

• Difficulty doing more than one thing at a time. This means an overemphasis on the most recent data to the detriment of other more important data

• Limited memory capacity. The more data available, the more likely we are to make bad decisions.

The major finding is that, essentially, investors are irrational and emotive and a number of their investment decisions can be emotionally rather than logically based.

As Fortuna puts it: “People have limited processing ability so they use rules of thumb. They think stocks are more predictable than they are and people think that what happened in the last three months is indicative of the future”,

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