Tuckett, David and Taffler, Richard. Fund Management: An Emotional Finance Perspective (August 2012).
CFA Institute Research Foundation, ISBN 978-1-934667-49-1, WBS Finance Group Research Paper No. 232,
Available at SSRN: https://ssrn.com/abstract=2616222
(For some reason, this free work is also available for sale at Amazon, where there are a few reader reviews.
https://www.amazon.com/Fund-Management- ... 934667498/)
The research is also summarized by the authors in a good, short, four-part video series called "Fund Managers Uncovered" by the same folks at SensibleInvesting.tv who made the videos "Passive Investing: The Evidence" and "How to Win the Loser's Game" that have been favorably discussed on the forum from time-to-time I believe.
Fund Managers Uncovered: https://www.youtube.com/playlist?list=P ... D87e1WX51g
Sensible Investing TV: https://www.youtube.com/channel/UCQblwA ... z-WvymNivg
(As an aside, the presenter of all these videos -- Robin Powell -- also has other videos his "The Evidence-Based Investor" site:
Based on depth-interviews with 52 "elite" equity-fund managers, the researchers (a professor of finance and a psychoanalyst) conclude (see the Part One video at 1:44) :
- "Fund managers are expected to achieve the impossible."
- "They are required to outperform other equally bright and well-resourced fund managers in a zero-sum game before costs. This is not something that even the most skilled are able to do on a consistent basis."
- "There is tremendous pressure on fund managers from the fact that they have an impossible task — that is they’re supposed to outperform when in fact most of them can’t. Statistically it’s impossible, because if you take into account fees then only about 30% of people in any one time period managed to outperform. So 70% therefore do not."
- "So ultimately, fund managers are slightly schizophrenic. On the one hand, they have to believe they can do something. But, on the other hand, they know that this is not possible. So they’re having to deal with this conundrum every day. And part of the way they deal with this is not to think about this conflict."
Although the researchers interviewed both stock-pickers and quant-fund managers, the bulk of the analysis is about the stock-pickers. I found the hundred-odd page work a quick and fascinating read and think it is important both for what it can tell us about professional fund managers -- and also about ourselves. For we are all amateur fund managers of a sort. (Or as Pogo might say: We have met the fund managers and they are us. )
In their analysis of the interviews, the researchers focus on the stories that fund managers tell.
Creating the conviction to act is not a simple matter of overconfidence as so often supposed. The strong impression we drew from our interviews is that most of our respondents are rather thoughtful and modest. It is the stories they generate that give them confidence and create belief.
We do not want to be misunderstood. We are not suggesting that our fund managers are irrational and that any old story will do. The stories they tell are about the things happening to companies, economies, countries, resources, and innovations and how they imagine, given all the information available to them, other investors would respond. In other words, they are stories about the fundamentals that, in the long run, should drive prices. Because the future is uncertain, however, how the stories will actually play out cannot be known directly or in advance. [p43]
On the one hand:‘The truth of a story lies not in the facts, but in the meaning’, writes Gabriel (2000), because ‘if people believe a story, if the story grips them, whether events actually happened or not is irrelevant’. The keys are ‘plausibility’ and coherence rather than ‘accuracy’ (p. 4). [p48]
On the other hand:The ability to tell convincing stories (to yourself as well as others) about your investments is key in generating the necessary conviction for the fund manager to enter into, and maintain, a relationship with a company and its stock. By smoothing over and creating coherence out of potentially very contradictory information, storytelling also helps anaesthetise the manager against the anxiety and stress associated with a job where investment outcomes are often unpredictable. In addition, our interviews clearly show that the stock of stories of investment successes has to be continually replenished with new ones. In this way, the fund manager’s confidence in his skill and ability to generate alpha on a consistent basis is continuously reinforced. [p53]
In short:In the stories they told about situations they had hoped would work out but did not, the typical plot has many of the well-known components of the tragic or tragicomic story genres. It is significant and interesting that because of the way the interviewees explained their failures through plausible stories, the failures do not appear to threaten the interviewees’ meta-narratives or underlying investment credos. If anything, paradoxically, through the medium of story, our fund managers are able to use such adverse outcomes to help reinforce their beliefs in the validity of their investment strategies and processes. This conclusion has an important implication: The market as a whole, fund managers, their investment houses, and their clients may have problems learning from experience. Storytelling, in the sense we have described, is a wonderfully flexible way of explaining misfortune and managing anxiety without threatening underlying beliefs. [p67]
The final section, "Using Emotional Finance to Understand the Asset Management Industry", gives a psychological interpretation of what the authors think is going on. (You'll have to read it for yourself to get the full flavo(u)r and nuance of their argument.)On some level, our fund managers ‘know’, but they do not ‘know’ or acknowledge or want to know or acknowledge the reality that what they are expected to do on a consistent basis is extremely difficult. Hope veils denial. [p95]
In particular:We think that, in some sense, investing includes the unconscious hope that it may be possible to find and possess phantastic objects. This key concept of emotional finance brings together the psychoanalytic concepts of object relationships and unconscious phantasy to describe subjectively attractive ‘objects’ that stimulate high excitement and almost automatic idealisation and, therefore, a powerful wish to possess. [pp85-86]
[The ‘ph’ in the spelling is conventionally used to differentiate the concept of unconscious phantasies from ‘fantasies’ in the vernacular sense of consciously constructed daydreams or wishful thinking. [p85 n48]]
The work concludes:A key insight that we gained from our interviews is that, given the pressures on fund managers to perform, they need to believe they can find stocks that others have not already identified, with which they can have special relationships. In emotional finance terms, they are searching for phantastic objects. [...] Viewed through the lens of emotional finance, then, fund management may at times seem to involve a never-ending search for phantastic objects that, in unconscious phantasy, offer phenomenal returns with low or, ideally, no risk. Importantly, note that this quest, however unrealistic it is in reality, is what fund managers are implicitly expected, by their clients and employers, to be able to do. We consider this understanding important. [p90]
I.E. the industry would have to operate "a la Bogle / Vanguard".As well as being required to outperform, fund managers have to carry many of the other emotional ambiguities the nature and expectations of the asset management industry creates, including the implicit denial or intolerance of the fact that the future is uncertain. The industry directly or indirectly sells the idea that its managers are able to earn superior returns on a consistent basis over time, which is what clients thus demand and believe they are signing up for in their mandates. In fact, as our interviews show, fund managers themselves equally believe, at least on some level, that they are able to consistently earn superior returns. We point out, however, that their high levels of anxiety suggest that, on another level, they are not so sure.
Only a more or less conscious belief that phantastic objects exist sustains managers every day and makes it possible for them to believe they can repeatedly outperform others as they are required to do. The fact is that fund managers themselves are, in some sense and without deep thought, being employed as phantastic objects. They are the phantastic objects that their clients, employers, consultants, financial advisers, and the media unconsciously need to be superior to alleviate the anxiety they experience because of the future being unknowable. A significant consequence is that asset managers are obliged to try to be such phantastic objects. To be a phantastic object, a professional fund manager must invest in phantastic objects (as discussed in the previous section)—namely, stocks that will generate high returns with low or, ideally, no risk. Fund managers have to believe that what others might view as frogs are, in fact, princes and what is perceived as base metal is really gold.
An industry that expects its foot soldiers to be phantastic objects clearly rests on problematic foundations. Reading through our interview transcripts, we see an industry built on a divided state of mind in which underlying reality (the improbability of consistently outperforming the market) is held at bay and questioning of the belief in the improbable is denied or repressed. Clients, asset management houses, commentators, and fund managers themselves are all joined together in groupfeel. Although the fund managers we interviewed are aware of the paradox we have been describing, the strength of group processes inhibits any proper examination of the paradox. In a divided state of mind, psychic excitement and short-term rewards dominate while prudence and caution are set aside. In groupfeel modality, mental conflicts between excitement and doubt are split—sidestepped or repressed—so the pleasurable feelings of group members are not threatened by the unpleasurable or painful and anxiety-generating ones. Such an unreal state of reality is hard to resist. Competitive pressures magnify rather than constrain this behaviour.
An important consequence of this kind of groupfeel in the industry is that few question whether the present structure of the asset management industry is in the best interests of clients or fund management houses. The fairly obvious divided state implied by current practices seems to pass unnoticed. The psychic excitement that accompanies a divided state of mind and the pursuit of phantastic objects is perhaps too strong and the short-term incentives too profitable for questioning the way in which the industry is currently structured.
An industry that was operating in a more integrated state of mind would have to eschew the belief in the existence of phantastic objects and clearly align the role of the fund manager with the interests of the majority of clients, who are saving for retirement. [pp91-92]
Interestingly, the authors claim that there is a residual important role for "active fund managers", but it sounds a lot like being passive-investing financial advisors (which, I presume, is why the video series was made by the SensibleInvesting.tv folks).
P.S. Somewhat tangentially the authors note that many fund managers claim that clients' actual expectations and often not the same as their stated expectations. Indeed:
This often causes fund managers to hew more closely to their benchmark than they otherwise would in an effort to prevent clients from withdrawing their funds. As one wag put it:‘Official mandates’ and ‘what clients expect’ are two potentially different things. [p77]
In other words, client skittishness often causes active funds to become closet index funds.‘The market can stay irrational longer than you can […] keep your clients.’ [p76]
Finally, bringing this all home ... .
It seems to me that, as DIY Bogleheads we are fund managers to ourselves and therefore that this analysis is applicable to each of us. However, there appear to be at least four key differences between Boglehead-ish and non-Boglehead-ish fund managers:
1) We have evidence-based stories (i.e. "scientific theories") can be (and are expected to be) falsified as they are continuously improved;
2) The evidence suggests that the future cannot be cost-effectively known and therefore, functionally speaking, "nobody knows nuthin'" (as Raymond famously told Bogle) -- except on a statistical/probabilistic basis; and therefore,
3) We manage periodically-rebalanced buy-and-hold asset-allocation portfolios appropriate to our need, ability, and willingness to take risk; and,
4) We help each other adhere to the maxim: "Don't just do something, stand there!"[/list]
In short, Boglehead-ish fund managers are fantastic because they are not phantastic