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Seven Sins of Fund Management

Picked up a link from The Big Picture to an interesting paper (warning, .pdf link) critiquing the behavior of fund management.

Paper was written by James Montier at the German investment bank Dresdener Kleinwort Wasserstein. The abstract:

How can behavioural finance inform the investment process? We have taken a hypothetical ‘typical’ large fund management house and analysed their process. This collection of notes tries to explore some of the areas in which understanding psychology could radically alter the way they structure their businesses. The results may challenge some of your most deeply held beliefs.

Anything that quotes ancient Chinese philosophy gets my attention. On forecasting:

Lao Tzu, a 6th century BC poet observed, “Those who have knowledge don’t predict. Those who predict don’t have knowledge”

On research:

The evidence suggests that in general more information just makes us increasingly over-confident rather than better at making decisions.

The argument isn’t “don’t do research”, but that most of the time spent researching companies/ideas should be towards proving contrarian ideas and not reinforcing an opinion. This leads to Sin #3 – why meeting with company management is a bad idea.

We aren’t good at looking for information that will prove us to be wrong. So most of the time, these meetings are likely to be mutual love ins. Our ability to spot deception is also very poor, so we won’t even spot who is lying.

If you consider an omission of fact to be a lie, then I would agree management in general is not particularly truthful. Other sins are short term time horizons (gee, haven’t heard that before) and groupthink. Turn on CNBC for 15 minutes and I bet you’ll see at least four of the seven sins in the first 15 minutes.

There is also lengthy statistical data backing this up. Both individual and institutional investors should print and read this.


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  1. BTW, Montier also produced a 350 page tome titled “Behavioural Finance: A User’s Guide.”

    But the PDF is terrific, and much more accessible

    Posted by Barry Ritholtz | February 14, 2006, 6:53 AM
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