The biases that disrupt good investment management

Research points to behavioural quirks that plague investors — as well as advisors — when it comes to decision-making

The biases that disrupt good investment management

With the increasing commodification of investment management services, advisors are increasingly exploring other areas to focus their value proposition. That includes improving decision-making by looking at human biases — something that even advisors may be guilty of.

As part of a series of white papers that tackle goals-based wealth management, SEI has published a report that focuses in part on the biases that affect financial advisors as well as investors.

When asked what emotions and biases dictate their clients’ investment choices, 576 advisors surveyed by SEI in April most commonly cited overreaction bias (36%), followed by hindsight (22%), belief perseverance (19%), and regret avoidance (17%).

Turning to the biases that affect advisors, the report referred to a poll conducted by the CFA Institute in 2015. Among the 742 investment professionals tapped for that survey, 34% cited herding as the behavioural bias that affects investment decisions the most. Confirmation bias was also identified (20%), along with overconfidence (17%), availability (15%), and loss aversion (13%).

“Our April 2019 financial advisor survey produced very similar results,” the report said. “Respondents identified with all five of the common biases we presented (overconfidence, hindsight, overreaction, belief perseverance and regret avoidance), but ranked overconfidence (26%) and regret avoidance (21%) as the top two behaviours they themselves must keep in check.”

While acknowledging the appeal of herding and confirmation bias to explain irrational decisions made by advisors, SEI argued that overconfidence plays a major role in their professional lives. It pointed to an analysis of 400,000 investment accounts published by Envestnet in May 2018, which found that over a three-year period, standard deviations in performance were much higher for advisor-as-portfolio-manager (APM) accounts and unified managed accounts (UMA) — both categories where advisors are responsible for or have a hand in managing the portfolio.

“Fund strategist portfolios (FSPs) generated both attractive returns and the smoothest ride for investors,” the report said, adding that APM and UMA models tended to have greater performance dispersion. Furthermore, volatility in APM accounts was said to be double what was observed among FSPs.

To minimize judgment errors that may arise from biased thinking, SEI recommended several techniques for advisors to adopt:

  • Developing disciplined, repeatable processes that can minimize short-cut thinking;
  • Making a habit of considering other possibilities by frequently checking one’s conclusions and recommendations;
  • Reframe errors as opportunities to learn and grow rather than as a reflection of their own competency or status; and
  • Check their ego and reflect on whether they are overly invested in being right as opposed to discovering what they might have missed.


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