Applying Behavioral Finance to Investments: The Existence and Importance of 'Investment Tribes'

Abstract

Investment organizations are complex to understand because decisions are the aggregation of multiple individuals who influence the process. This applies to organizations that apply both quantitative and qualitative investment approaches because the first step in a quantitative approach is still a qualitative statement of the investment hypothesis that is then formalized by the models. Increasingly, finance practice is starting to incorporate behavioral finance insights and recognize that individuals are not “rational utility maximizers”, but rather complex psychological beings that can exhibit non-traditional behaviors. Kahneman-Tversky (KT) introduced this notion of individuals being “humans” and not “econs” but made broad generalizations about behaviorally affected decisions (BADs) and did not provide a methodology to examine individual biases. A technique has been proposed to use KT’s questions to provide individual behavioral diagnostics and previous research demonstrated dramatic differences within and across groups based on age, gender and financial literacy, especially for gambles based on prospective gains and losses. This paper is a case study of a single asset management company that uses a mix of quantitative and qualitative investment techniques, driven by five decision makers with equally weighted votes in the final decision. In addition to demonstrating that each individual in the investment committee is unique and providing individual diagnostics that show that age, gender and education need not lead to a particular behavior, this paper highlights the fact that organizations have “investment tribes”; namely, that there are groups of individuals who appear to exhibit similar risk tendencies for gambles involving gains or losses. These tribes can influence and impact decision-making. Quantifying and making transparent the existence of these tribes could improve decision-making. This case study can be helpful for investment firms allowing them to become aware of potential biases, and also for asset owners that delegate decisions to third parties, as it allows them to understand how the investment firms they delegate to might behave when they experience drawdowns.