How managers are accounting for bias Managers aware of behavioural bias try to account for it in various ways. Some try to be objective by slicing their portfolio – prescribing a sell-by date for a particular stock that is adhered to regardless of market or manager sentiment. Others treat selling like buying – re-evaluating a stock by asking if it would be bought today if it was not already owned. If the answer is no, the decision is sell. But not everybody wants behavioural biases to disappear. While they cause some people to be overly optimistic and underperform, they also create the mispricings that allow other investors to take advantage and outperform. Exploiting optimism bias is about timing the correction, Bird says. “Shares are on average overpriced because of optimism, but knowing that alone doesn’t really help. Say that a share is 10 per cent overpriced because nine out of 10 managers are over-optimistic about its potential. Now, I’m the one out of 10 who thinks the market’s always overpriced, but if it stays overpriced that is no good to me.

I might know that this stock is 10 per cent overpriced; but that is of no use if it stays 10 per cent overpriced for the next 12 years.” Some managers adjust for this by adding at least a degree of momentum style to their investment philosophy. MIR, a quant-orientated manager which blends value and momentum, has an investment process based around trying to exploit mispricings caused by behavioural biases of other investors while attempting to guard against falling into such traps itself. From academic and in-house research, MIR says that when correcting, stock prices tend to under-react to individual information signals, but over-react to a series of like signals. Subject to confirmation bias, the lone pieces of information are ignored because they go against the manager’s conviction, but as such information becomes ubiquitous and the manager begins to change its mind, each additional piece of information confirms the new hypothesis. To time the change in sentiment that leads to a correction (or over-correction), MIR designed a quantitative process that delays investing in cheap stocks until they have demonstrated some improvement in momentum/sentiment, which suggests they are either in the early stages of, or about to enter, a recovery phase. In addition to the quantitative screen, MIR has an analyst evaluate the stocks selected from the screen to identify those for whom recovery is not imminent.