There are as many investing strategies out there as there are investors. One of the more complex claims to base decisions off of human behavioral patterns. There’s plenty of science out there detailing how we humans make decisions. Some investors have built portfolios around that science and claim to beat the broader market with it.
Once such investor is C. Thomas Howard, author of Behavioral Portfolio Management. Howard manages the AdvisorShares Athena High Dividend ETF (DIVI) which uses some of this science. “If individual investors make mistakes, collectively they make mistakes,” Howard says. “That must influence prices. So our idea is that prices rarely reflect fundamentals and that there’s price distortion in the market constantly.”
It’s not just individual traders that these individual decisions impact. It is relevant to institutional investors too. Howard notes the fact that they are making decisions for emotional individuals, those “emotional individuals will put that pressure on them” to make those decisions and the behavioral vicious circle continues.
Howard and his team have taken that knowledge and, using large amounts of data over long periods of time, “look for measurable and persistent distortion…[and] build portfolios to harness those particular mistakes.” He says those portfolios outperform the broader market by 400-600 basis points, enough to at the very least take a second look at his strategy.
How though can Howard remove his own behavioral predilection out of the equations? After all, he may be looking at data to support an individual trade, but ultimately he is making the call. The solution sounds simple but it isn’t. “Step back and say ‘am I making an emotional decision or am I basing it on careful analysis...is there a consistent relationship I can build a portfolio on?’” Just like an athlete trains to perfect their sport or a surgeon his or her skills, a behavioral portfolio manager must train themselves to ignore their emotional response to a potential investment.
Whether you buy the science or not, Howard offers valuable advice for anyone looking to beat the market. “You’ve got to say ‘I’m willing to be quite different and not listen to what the other people are saying,” or as he told us: come up with a strong, well thought out strategy that is different, and have the courage to stick to it.
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