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Improve your asset allocation decisions by applying behavioral finance

To remain competitive, medium- and smaller-sized wealth managers need to either grow aggressively in size to play a shaping role in the industry’s concentration process or take on the competition with investment management fintechs in offering low-cost, fully automated wealth management solutions.

It is apparent that both these options are out of reach for many investment service providers as they are too small, too conservative and/or too loaded with overhead costs. So, assuming they want to survive, they will have to target a niche where they can exploit an innovation-driven competitive edge. This means becoming a learning organization with a continuous improvement cycle. We regularly ask investment management decision-makers and investment committees how they learn. Silence is the most frequent response.

Structural Factors of Underperformance

Our consulting work with professional money managers raised awareness of areas resistent to change. Underperformance of professional investors versus the market is dominated by two structural factors. The first is a straightforward cost penalty incurred due to transaction costs, management fees, distribution fees, etc. The second is the “Behavior Gap Penalty”, defined as the contribution of the human factor to a biased perception of reality caused by cognitive dissonances. Indicators of the penalty along the investment process include certain market timing techniques, the application of flawed portfolio optimization techniques, minimizing career-risk as a primary objective and other expressions of cognitive biases.

In order to minimize both penalties, the investment process should be optimized towards the goals outlined in the illustration below. 

 llustration   rganizational ptimization  anthera olutions

Illustration A – Organizational Optimization
© Panthera Solutions

Creating High Performance Investment Teams

A team capable of minimizing both penalties while maximizing the goals above has to be able and willing to oscillate between the operational and meta-levels in its qualitative and quantitative optimization of the investment process. How to create what we at Panthera call a High Performance Investment Team (HPIT©)?

Part of the Bonhill Group.