Review: How fear and greed can be your friends
Are we rational investors? A new book demonstrates why it pays to understand the tenets of behavioural finance.
“The investor must desire according to the mean variance maxim [and] we must be able to arrive at a reasonable probability belief on future performance of securities.” Harry Markowitz, 1952.
On the first day of the fund congress in Mannheim in January, all that more than 100 investors ‘desired’ was to push, at the same time, through one door, to hear Martin Weber of the University of Mannheim speak on behavioural finance, in a lecture simply entitled: ‘Are we rational?’
It was one of the most popular talks at the two-day event and, with some irony, one delegate said to his colleague as they both squashed through that door: “Do you realise, we are demonstrating absolutely perfectly the power of a herd mentality?”
Squashing through entries and running at crowded exits was arguably what markets spent much of last year doing, driven by the animal instincts of fear (risk-off) and greed (risk-on), and now in Mannheim people clearly wanted to know why.
Politicians didn’t help inspire confidence in 2011 as they held summits whose outcome was “binary, and normally painful”, according to one German-based equities fund manager. Last year, as in 2008-09 and 1999-2000, markets remained ‘irrationally’ driven for longer than many people could stay in business.
When America was downgraded by Standard & Poor’s, investors rushed to buy securities from the same issuer (Washington) that had just had its credit-worthiness cut. And as Germany became more burdened by guarantee promises, they actually paid Berlin, on at least two occasions, to let them lend it money.
Of course, some investors chose their own ways of acting irrationally. For example, Dean Curnutt, CEO of Macro Risk Advisors, said recently: “As we saw a circumstance such as Greece, most of the people we talked to, with plenty of analytical capabilities to understand that situation, sat it out.
“The implications, if you took the worst case scenarios for Greece, from wholesale redenomination of contracts to full collapse, were more than people could get their heads around, so they decided not to focus on it.”
It is hard to argue that a market is the result of all its participants’ rational opinions about its price, if some are simply saying: “This situation, and its potential effect on my portfolio, is just too difficult even to think about.”