Viewing investors and markets as emotional decision makers rather than as rational computational entities forces us to reconsider every aspect of how we operate in financial markets. The behavioral financial markets concepts I discuss below provide a framework for rethinking client financial planning, asset allocation, investment manager selection and the creation and execution of investment strategies.
A recent article summarized the predictions of 500 advisors for the 10-year returns for a number of asset classes. If advisors construct portfolios based on those forecasts, they will destroy significant portions of their clients’ wealth.
Active equity performance depends on the stock-picking skill and market conditions. Recent academic research confirms that returns to stock picking rises in tandem with increased stock return cross-sectional dispersion and skewness, along with greater market volatility.
Forty years of behavioral science research provides a more realistic framework for viewing investors and markets than does MPT.
My firm, AthenaInvest, has conducted extensive research on the use of behavioral factors to estimate expected returns and, in turn, to make market-rotation and beta-exposure investment decisions. The following article outlines our behavioral approach and compares the results to a passive benchmark.