Show 74 – Behavioural Finance

Recorded in partnership with CFA UK from their conference in London on the topic of ‘Behavioural Finance in the age of algorithms’, we interviewed the five speakers from the event. Our guests were:

1. Markus Schuller, Founder and Managing Partner of Panthera Solutions
2. Philippa Clough, Portfolio Manager at JP Morgan Asset Management International Equity Group
3. Kristina Vasileva, Senior Lecturer in Finance at Westminster Business School
4. Shweta Agarwal, a member of BlackRock’s Risk & Quantitative Analysis Group
5. Magda Osman, a Reader in Experimental Cognitive Psychology at Queen Mary University of London

Markus Schuller – Human ambiguity tolerance beats artificial intelligence

Markus Schuller

with Markus Schuller

Markus is Founder and Managing Partner of Panthera Solutions and his talk was titled ‘Human ambiguity tolerance beats artificial intelligence’.  He explained that ambiguity tolerance is about maximising the contribution of intellect and reason to our decisions in a complex environment.

In his talk, Markus explained about how the limbic system in the brain manages and modulates our emotions and that it’s not just what’s happening between our ears but also how much adrenalin is in our veins and how emotionally aroused we are as a consequence, which can be positive or negative.  He also discussed a number of other topics including resistance to change and knowledge management.  He also had an interesting take on Diversity, because as well as gender, ethnicity and age, he said it’s important to also maximize cognitive diversity, because if we are socialized in a very similar way, then our perspective on the world is similar.

Markus’ view on AI is that we’re far away from the point of it replacing humans in the asset management industry, but that it is technology that can support us to make more evidence based decisions.  It’s much faster and more concise when it comes to fundamentally analysing thousands of stocks at once, but it’s not yet ready to replace us when it comes synthesizing qualitative and quantitative factors when interpreting data.

Markus has written a number of blog posts for the CFA UK, which are highly recommended for additional reading and explanation of all the topic areas he spoke about.  They are on the topics of:

  • The Knowing-Doing Gap in Behavioral Finance
  • Ambiguity Tolerance Beats Artificial Intelligence
  • Survival Strategy: A Learning Investment Team
  • Benchmarking Multi-Asset Portfolios: The Global Capital Stock

All available at the CFA UK Blog

Philippa Clough, Reflections from 20+ years of behavioural finance investing

Interview starts at 8min22s

Philippa Clough is a Portfolio Manager at JP Morgan Asset Management International Equity Group. She has a Masters in Mathematics from Oxford University and is a CFA Charter Holder and was presenting at the event on ‘Reflections from 20+ years of behavioural finance investing’.

Philippa Clough

with Philippa Clough

Philippa said that she works in a team of 40 investors who use behavioural finance insights in order to determine how they direct their investment insights and that they apply behavioural finance insights into two areas:

  1. to stocks and what impacts how stocks are priced
  2. to themselves – she explained that if we think other people are biased, it’s probably quite likely that we’re biased ourselves and we try and think about ways to enable us to make more rational decisions.

Philippa talked about earnings calls to explain it a little more.  She said that as an investor listening in to the call where the company is talking to their investors and updating them on the company is doing, you will have expectations of how it’s going to go in the future. As an investor, you may say, “OK that’s interesting. Well, company management are biased. They tend to be overly optimistic on their future prospects.” So, as an investor, how do you think about that information that’s just come out about the company and the strategy? How do you balance with the rest of your opportunity set? One way to approach that is to listen to lots of other earnings calls so that you get a base of comparison. However, there are a lot of companies in the world, and Philippa said there are 2000 in Europe alone that they consider investable, and as an analyst, it could take you two years to listen to all 2000 calls, which happen on a quarterly basis, and get through that level of information, which is obviously not feasible, especially if you have certain weeks where they may have 100 calls to listen to.

Instead, Philippa said that they have applied natural language processing techniques to automatically calculate the sentiment for an earnings call. This enables them to tell whether it’s positive or negative, which means they can then direct investors to focus most of their time on the ones where the sentiment is particularly extreme relative to comparable companies in comparable industries. It therefore enables them to focus their time on where they think they are going to be able to gain the most insights that are going to be informative for future stock performance.

Philippa said that technology therefore plays a key part in the job, but not just about looking at stocks, as in the example above, but in themselves too.  She said that on average, people are overconfident, and gave a common example to explain it, which is the question whether you think you’re better than average at driving?   When asked this question, 90% of people will tell you that they’re better than average at driving, yet it’s a 50:50 statistic, meaning  40% of those people are going to consider themselves overconfident. Philippa said that if you are overconfident and you have more conviction in your insights, then you sometimes discount the likelihood that maybe you’ve got it wrong or what the probability of things are not turning out how you expect. From a portfolio perspective, that means that you can end up owning large positions in companies, which have all very concentrated risk and also turning over your portfolio more than you should.

Philippa said that “we use technology to make us make more rational decisions is by having quite a sophisticated risk analysis framework. So, we want to cut the risk of your portfolio or your exposures through many different lenses to say stop, think and make sure that the decisions in the weightings that you’re placing or the amount that you own of a company, can measure it with the risk and your return expectations.”

Philippa said that knowledge in behavioural finance is growing but it’s definitely not what the majority of people are doing. However, she thought that 2017 was an amazing year for the topic area, as Professor Richard Thaler won the Nobel Prize in Economics and in the same year, also starred in ‘The Big Short’ alongside Selena Gomez, which Philippa said  is unusual for someone who spent their time thinking about how psychology fits into investing!

Philippa believes that events like the CFA Behavioural Finance conference are brilliant, whether you’re an investor or someone who focuses on other areas of finance, because it really makes you stop and rethink your behaviours and your decisions, even if it’s not in your day to day job.

To finish off, she gave one example of a behavioural bias that might be easier for anyone to understand, which is called ‘Home Bias‘, where people prefer things that they’re more familiar.  She used the example where someone who works in her team is a big Arsenal FC supporter and in his Fantasy Football team, has always had a bias towards including players from Arsenal.  She said this could be similar to how it affects people who invest in only one country, perhaps just UK companies because you’re more familiar with them.  Phlippa said that fine if all your expectations of future payments are going to be in the UK, but what if you have something like the UK referendum and your currency suddenly devalues by a good 10-12%, potentially where you’d allocated your assets doesn’t fit your future returns and isn’t optimal.


The remaining show notes will be uploaded soon.

For more information from CFA UK, visit www.cfauk.org


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