Tag Archives: Behavioral Finance

On The Limits of Perception, The Power of Math, and Human Behavior

Here is the English version of my most recent article in Forbes Latvia. If you are heavily invested in technology stocks, you might want to pay particular attention…

I am going to tell you a story whose provenance I cannot ascertain, but that speaks to the limits of perception, the power of math, and human behavior.  

The one constant of this story is that there is a chessboard. Other key components are 1) a king or emperor, (2) a man, and (3) grains.  

Now at this point you might have guessed the story, but you will remember it the way you first heard it, and will most likely not know the alternative endings. For those of you who have no idea what I am talking about, here we go…  

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Kā emocijas un uzvedība ietekmē investēšanu?

Ir pagājis kāds laiciņš kopš mana pēdējā raksta, jo esmu bijis nedaudz aizņemts. Pavadīju divas nedēļas ASV, kur redzēju, kā apprecas viens no maniem vecākajiem draugiem un pirmo reizi divu gadu laikā satiku brāļus un māsas.

Bet, pats svarīgākais, es otrdien apprecējos ar cilvēku, kuru bezgalīgi mīlu un apbrīnoju.   

Šis ir bijis laimes un pozitīvu emociju pilns laiks, tāpēc par kādu labāku tēmu rakstīt nekā par emociju un uzvedības ietekmi uz investīcijām un tirgiem? Šeit ir neliels ieskats par šo tēmu:

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Most Investors Think They Are Contrarians

Here’s a link to a great article from Morgan Housel @ The Motley Fool about how investors tend to perceive themselves:

LINK: Everyone Thinks They Are Different

I would only partially agree that “contrarianism is the key to huge outperformance”. The size of your allocation is of paramount importance as well. At the end of the day, the market doesn’t care about your style or your philosophy. What matters is whether you win or lose, and if you live to fight another day. There are no ‘beautiful losers’ in this great endeavor – contrarian or not. read more

Contrarian Investing – Emerging Markets Edition

I attended a number of panel discussions and seminars on the state of Emerging Markets at the JPMorgan Emerging Markets Corporate Bond conference last week.

I noticed two things in particular: (1) there did not seem to be all that many people in attendance, and (2) there were many South Americans.

Initially, it seemed strange to me that someone would fly 8 hours from Santiago, Chile to hear about their country’s corporate bonds (OK, fine, 4 days in Miami Beach is not a tough sell…). However, considering the brutal state of Emerging Market bonds and equities – especially Latin America – over the past year, it soon became obvious that many had made the trip to just clear their heads and get some group support.

The sentiment expressed by many of the South Americans was that, sure, things have been better, but its not that bad. That being said, it’s tough to keep positive when your positions are selling off every day for months at time.

On the other hand, the US High Yield & Leveraged Finance conference was packed.

We have been a little bit early in adding Emerging Markets positions in our portfolios over the past number of months, both in bonds and equities, but the recent activity in both asset classes has begun to reap some nice rewards.

Buying at the bottom is an elusive practice. But history has shown that buying out of favor, quality assets when they have sold off tends to reap excellent rewards for patient investors.

Here’s ETF.COM’s Larry Swedroe on how investors tend to skew towards a “recency” bias when choosing their investment allocations:

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Kristaps Porziņģis, Knicks Fans and Behavioral Finance

In this post, Josh Brown delivers a mea culpa on behalf of Knicks fans regarding their initial negative reaction to their team drafting Kristaps Porziņģis.

Brown draws parallels to how we as investors anchor our perceptions and reactions to our previous experiences (availability bias). Moreover, he explains how we most often give into gut reactions that we presume to be logical and well thought out, when they are actually not (first level thinking -vs- second level thinking).

There are a few more things that I would like to add. Brown makes note of Knicks fans wanting to ‘win now’. This is not something that is exclusive to New York or to sports fans in general. Everyone wants to win, and they don’t just want to win ‘now’, they want to win all of the time. Investing is no different.

The best sports franchises and investors understand that you have to have a long-term plan and be disciplined and decisive in executing your strategy. You can’t constantly jump around and make impulsive decisions to try to make returns, especially if you are putting yourself at the mercy of short-term market sentiment. The Knicks’s President Phil Jackson understands this. Phil Jackson has won 11 NBA championships as a coach and two as a player. In fact, it seems ludicrous to question anything that Phil Jackson does when it comes to basketball, but still, New York fans were outraged when he drafted Porziņģis. According to Knicks fans, Jackson, a ‘Zen Master’ and winner of 13 NBA titles had obviously lost his mind.

The second thing is that most Knicks fans wanted their team to draft Justice Winslow. This seemed to make perfect sense. Winslow was a talented freshman who had just played the game of his life by leading the Duke Blue Devils to the NCAA championship. This sentiment was a classic case of how investors often get drawn into ‘buying the winners’. We see an investment do well, and assume that it will continue to achieve the same results without considering how circumstances might have changed. Winslow may very well turn out to be a good NBA player, but in Porziņģis, Jackson saw an undervalued asset, with unparalleled growth potential that could be future game changer. He no doubt also put great value on what he saw from Porziņģis’s family, because even the most exciting companies can fail without good management and support.

Porziņģis’s performance has been phenomenal. But imagine, if he had to wait a season before getting to play in the NBA, or got injured before playing significant minutes? Fans would still be screaming for Jackson’s head! Sometimes sentiment or minor distractions derail our investment decisions as well. A couple of years ago I bought Amazon stock because they seemed destined to conquer the retail business (in basketball terms a 7’4″ shot blocker with good hands that could hit 3-pointers… just like Porziņģis). Then they came out with their cell phone. It was a not a hit with customers or investors. Surely something was wrong at Amazon! How could they have thought this would be a success? Had management lost their minds? I got out and waited for sentiment to turn. Two earnings reports later sentiment turned, and it turned hard. Within a year, Amazon stock had doubled in value. I missed an opportunity whose potential had been quite clear to me from the very outset, because I had chosen short-term gain (loss avoidance) over long-term growth potential. This concept is especially relevant in the current market environment where investors are shunning compelling value.

These days sentiment is extremely volatile, but we’re hard at work trying to find the next “Porziņģis” for our client portfolios.

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