Crowd PsychologyAnalysing group decision-making dynamics to fortify Analysing group decision-making dynamics to fortify

investment strategies and committees

Greg B DaviesHead of Behavioural and Quantitative Investment Philosophy

@GregBDavies

2

Sell date,

quarterly

7070

75

75

80

80

85

85

90

90

95 00 05 10

If you bought in 1975 and sold in 1995,

your average annual return would have

been 12%

MSCI World Equity Buy date,

95

00

05

10

Equity Annualised Returns

<-5%-5% to

0%

0 to 5%

5 to 10%

10 to 15%

>15%

Buy date,

quarterly

Past performance is not a reliable indicator of future results

Source: MSCI World Index, 1970

- August 2011, Barclays Wealth

7070

75

75

80

80

85

85

90

90

95 00 05 10Sell date,

quarterly

Buy date,

quarterly No nominal losses over any holding period of 12 years

or more

MSCI World Equity

95

00

05

10

Zone of Anxiety

<-5%-5% to

0%

0 to 5%

5 to 10%

10 to 15%

>15%

Equity Annualised Returns

Past performance is not a reliable indicator of future results

Source: MSCI World Index, 1970

- August 2011, Barclays Wealth

Myopic Loss aversion and the Anxiety premium

Probability of loss at different holding periods

25%

30%

35%

40%

45%

In times of stress our emotional

time horizon shortens and

distorts our risk perception

Zone of Anxiety

Source: MSCI World Index, 1970 - August 2011, Barclays Wealth

0%

5%

10%

15%

20%

25% distorts our risk perception

1 2 3 4 5 6Holding period (years)

Past performance is not a reliable indicator of future results

Emotional liquidity: the journey matters!

Which investor is happier at the end?

(Green, black or red)

Port

folio

Retu

rn

Danger of buying high

66

Time

Danger of selling low

Financial Personality Assessment

Traditional Approach Barclays Wealth Approach

HIGH

CO

MP

OS

UR

E

EN

GA

GE

ME

NT

Risk AttitudeHIGH HIGH

PE

RC

EIV

ED

FIN

AN

CIA

L

DE

SIR

E F

OR

DE

LE

GA

TIO

N

HIGH HIGH HIGH

Decision StyleHIGH

TO

LE

RA

NC

E

Risk Tolerance

8

LOWC

OM

PO

SU

RE

MA

RK

ET

EN

GA

GE

ME

NT

LOW LOW LOW

PE

RC

EIV

ED

FIN

AN

CIA

L

EX

PE

RT

ISE

DE

SIR

E F

OR

DE

LE

GA

TIO

N

BE

LIE

F IN

SK

ILL

LOW LOW LOW

RIS

K

TO

LE

RA

NC

E

Personality and the Zone of Anxiety

Me

an

Pe

rso

na

lity

Sc

ore

s

4

Risk Tolerance Composure

I buy and sell investments more than I should

Source: Barclays Wealth Insights Volume 13

Me

an

Pe

rso

na

lity

Sc

ore

s

2

3

Disagree Agree

Becoming a better investor

Pro-cyclical Counter-cyclical

Skill Required Requires clairvoyance,

not skill

Reactive InvestorBuys high, sells low

Constant InvestorRegular

rebalancing

Tactical InvestorTactical rebalancing

The SeerBuys low, sells high

10

Emotional Difficulty

sells low rebalancing sells high

Attempts to time

the market are

dangerous

A countercyclical

tactical approach

is likely to pay off

A little composure

can significantly

increase returns

Most investors

follow this pro-

cyclical pattern

Difficult to avoid

temptation

Teams can outperform individuals…

� Estimating (wisdom of crowds)

� Weather forecasting

� Problem solving

The only function of economic forecasting is to make astrology look respectable

J. K. Galbraith

Estimating the weight of a bull Forecasting financial markets

11

The Cycle of Market Emotions

Exuberance

DenialExcitement

OptimismFear

Irrational exuberance

due to fear of missing out

and herding

12

Reluctance

Panic

Fear

Despondency

Desperation

Capitulation

Reluctance

Depression

Apathy

Indifference

Anxiety premium

Weaknesses of groups and teams

We associate with people more like us

than random: default group of members

tends to not be very diverse

When we learn others opinions we tend

to over-weight their opinions, especially

when they agree with us

1. Homogeneity 2. Contamination

1313

We worry about publicly disagreeing with

others for social or authority reasons, so

tend to agree with leaders opinions

We don’t put effort into finding

information and thinking out our own

opinion when we know others will be

supplying their views

3. Conformity 4. Social Loafing

We underestimate how differently others see the world

14

30%

40%

50%

30%

40%

50%

Bears: Others investors are bearish

…and how differently others see the Market

Bulls: Other investors are bullish

0%

10%

20%

Large

loss

Small

loss

No

change

Small

gain

Large

gain

0%

10%

20%

Large

loss

Small

loss

No

change

Small

gain

Large

gain

Bear’s OpinionSource: Egan, Merkle, Weber, “Naïve Realism and Investment Decisions”, Manuscript, 2011, based on Barclays Wealth 2008-2010 survey of 620 UK-based investors.

Bulls Opinion

Weakness: Conformity

16

On average…

Risk

Tolerance

Composure Market

Engagement

Perceived

Financal

Expertise

Delegation Belief in Skill

Individual variation matters

High

Risk Tolerance

Risk

Tolerance

Risk

Tolerance

Composure

High ComposureComposure

Low Low

Com

posure

Composure and Risk Tolerance

High

Risk Tolerance

Com

posure

HighLow

Low

Delegation

High DelegationDelegation

Belief in Skill

High Belief in SkillBelief in Skill

Individual variation matters

Low Low

Being greater than the sum of your members

Every trustee will have their own information and facts, but

not necessarily all the relevant factsDiversity

Some trustees focus on specific areas, becoming better or

more efficient at gathering or using informationSpecialisation

22

It’s very important that people's opinions are heard openly

and aren't limited by other group membersIndependence

Mechanism required for turning private judgments into a

collective decision. Some are better than othersConsensus

23