The behavioural investment edge

Exploring the durability and replicability of investing edges.

1 minute read

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Investing is a pari-mutuel system where the gains are divided among the participants. Unlike casino gambling, which is a zero-sum game played against the house, active investors compete against each other. Therefore, an answer to the question, ‘what’s your edge?’ is pertinent. Market inefficiencies can be categorised into four buckets: technical, informational, analytical and behavioural.

If you can keep your head when all about you are losing theirs…
If, Rudyard Kipling

The best illustration of a technical inefficiency is spin-offs. Institutional investors occasionally receive de minimis quantities of stock in a restructured company that is generally a peripheral part of their investment thesis and eject the unwanted holding. They aren’t strictly forced sellers, but they are certainly less careful. However, spin-offs are also an example of the transitory nature of technical inefficiencies; they have flipped from outperforming to underperforming the index since the first coming to the market.1

Informational edges have also been subject to decay. Accounts of successful investors operating in the twentieth-century are replete with stories of chance management meetings and the strenuous effort involved in simply getting hold of company accounts.2 If markets can never be perfectly efficient because there are costs to gathering information, it is undeniable that thanks to the internet the cost of information such as annual reports, press releases, strategy presentations, conference call transcripts and management access is now readily available.

However, information requires analysis in order to separate what is merely interesting from what is truly important.  Analytical edges – asking different questions of the publicly available information and processing or weighing it differently to others – can be a source of advantage.  For example, we focus more on cash than earnings; we appraise the outlook for a company over the next decade not just the next quarter; we tune down macroeconomic prognostications. Unfortunately, even these points of differentiation are ultimately transitory.

Behavioural inefficiencies are the most interesting because they are systematically exploitable and not able to be arbitraged away as they become more widely known; people are not (yet) able to alter their psychology. Few investors think about thinking nearly as much as they scrutinise their performance. Various tweaks to otherwise common fund management practise include keeping diaries of our decision-making to mitigate hindsight bias; deactivation intra-day portfolio valuations because they are trivial; fostering concentration by having fewer screens on our desks; deactivating the historic book cost of investments to mitigate anchoring; and company analysis that purposefully seeks out disconfirming evidence.

Key risks

For further information on the risks and risk profiles of our funds, please refer to the relevant KIID and Prospectus.

The value of an investment and any income from it can go down as well as up and can fluctuate in response to changes in currency exchange rates. Investors may not get back the original amount invested.

Emerging markets risk

The fund invests in emerging markets; these markets may be volatile and carry higher risk than developed markets.

Derivatives risk

The fund uses derivatives; these can be complex and highly volatile. Derivatives may not perform as expected, which means the fund may suffer significant losses.

Illiquid securities risk

Certain assets held in the fund could, by nature, be hard to value or to sell at a desired time or at a price considered to be fair (especially in large quantities), and as a result their prices could be very volatile.

Concentration risk

The fund invests in a small portfolio of securities. Losses from a single investment may be more detrimental to the overall fund performance than if a larger number of investments were made.

References

  1. Invesco S&P Spin-Off ETF
  2. Alice Schroeder, ‘The Snowball: Warren Buffett and the Business of Life’, Bantam, 2009

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Important information

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (“Aviva Investors”) as at November 2019. Unless stated otherwise any opinions expressed are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. 

Past performance is not a guide to future performance. 

The Prospectus and Key Investor Information Document (KIID), are available, together with the Report and Accounts of the SICAV, free of charge from Aviva Investors Luxembourg, 2 rue du Fort Bourbon 1st Floor.L-1249 Luxembourg, Grand Duchy of Luxembourg R.C.S. Luxembourg B25708, Aviva Investors, St Helen’s, 1 Undershaft, London EC3P 3DQ The Prospectus is available in English and German. Where a sub fund of the SICAV is registered for public distribution in a jurisdiction, a KIID in the official language of that jurisdiction will be available.

Issued by Aviva Investors Global Services Limited, the Investment Manager to the Fund registered in England No. 1151805.  Registered Office: St Helens, 1 Undershaft, London, EC3P 3DQ.  Authorised and regulated by the Financial Conduct Authority (Firm Reference No. 1191780).