Human Nature Dictates How We Invest, Not Logic: New Study Shows

July 7, 2018 James Heinsman In the News

Despite the mounting empirical evidence that passively investing in exchange-traded funds and other index type funds, money continues to flow into managed hedge funds with active fund managers.

A research paper published in June concludes that the idea of realizing higher returns by doing less seems too good to be true to investors, and they therefore continue to give their money into the hands of stock-pickers, even if their fees and performance sucks out the value for their customers.

Authors of the report, J.B. Heaton- soon to be the law and business fellow at the University of Chicago Law School; and Ginger Pennington- an assistant professor at Northwestern University’s Department of Psychology, explain that people are simply pre-programmed to believe the well-advanced myth about active investing.

“Despite clear evidence, it may simply be too difficult for a substantial number of investors to believe that superior returns are available by doing nothing but investing in an index fund rather than investing with active managers,” the paper says.

Yes, EFTs are the recipients of a surge in capital, as they should be, but hedge funds have been outdoing themselves lately. New money has been added to the hedge fund industry for four quarters in a row. The niche saw $1.1 billion of net influx during the first three months of 2018. In addition, new funds popped up on the scene more often than old ones closed for three consecutive quarters.

In a different study done by the British Psychological Society in 2003, 107 traders in London from four investment banks were tested. They were told to make the line on a graph go up as much as possible and were told that by pressing certain keys on the keyboard every one-half second might affect how the line grows.

In truth, the line on the chart developed randomly. But when the subjects were asked how much influence they thought they had on the line by pressing the keys, the traders who had earned the lowest bonuses and had the lowest profits for their firms were the very ones most convinced that their interventions had some effect.

Heaton and Pennington conclude that the marketing strategies for the asset management industry should be forced to add warnings, like those of cigarette ads. They suggest something like:

“Many active investment strategies under-perform more inexpensive alternatives. Ask your broker for more information.”

EFTs, Hedge Funds, Index Funds,

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