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On the defensive

James Montier is not a household name, although you may have come across the research he undertook as as global strategist at Société Genérale. He now does much the same thing at asset manager GMO and his newly published Little Book of Behavioural Investing is a must-read for investment advisers. It suggests corrective measures for the biases that cause investors to torpedo their own ships.

Montier punches home the message that the X-system – our quickfire gut response – tends to override the cooler, C-system of reason and analysis whenever there is fear, stress or uncertainty – which is most of the time in the stockmarket. The results are often messy.

It is not surprising that the best long-term investors tend to be ice-cool characters like Anthony Bolton, who can clearly override their X-system responses. But if you are not like them, you need defence mechanisms against behavioural biases.

Most of us have the over-optimism bias. The trick for advisers is to try to act as if you are the owner and not the client.

If your answers are along the lines of “everyone else does”, “it is in the newspapers”, “the clients like it”, “it is a top-selling fund”, “it has a five-star rating” or “the fund managers say it’s hot”, then you are buying for the wrong reasons – and if the wheels come off, it will be your fault.
If you buy for the right reasons, which requires analysis rather than go-with-the-flow emotion, then even if it does go wrong you will not be at fault.

The X-system – our quickfire gut response – tends to override the cooler, C-system of reason and analysis whenever there is fear, stress or uncertainty – which is most of the time in the stockmarket

Advisers could probably use pre-commitment to achieve better results. This was Sir John Templeton’s weapon of choice. How do you decide what to do in the middle of a manic sell-off like that which occurred in March 2009? You refer to your watchlist. You have previously created a list of investments you would buy if they were cheaper, which is updated regularly. Now they are cheaper, so you buy them.

Templeton left standing orders with his brokers as he knew he might not have the fortitude to pick up the phone amid the panic. Those orders meant he bought anyway.

Another killer is confirmatory bias. It takes about five times as much data to get someone to change their mind as it did to adopt a view in the first place. This is why analysts’ forecasts for company earnings are always wrong. The defence is to get into the habit of using counter-factuals and what-ifs to help change your mind when the facts change.

I am amazed at how many manager and economic commentaries a contain forecasts of various kinds. As Montier reminds us, forecasts are junk. They are not only wrong but they feed a pernicious bias, anchoring on a number.

A good way to deal with this is to train yourself to think in terms of ranges rather than specific numbers. If you do this, you will find yourself wondering about the probability of the result falling within that range, and then you will be using the C-system for what it is good at – helping you make better investment decisions.

Chris Gilchrist is director of Churchill Investments and editor of The IRS Report


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