Saturday, September 13, 2008

The New Contrarian Investment Strategy: Chp 12: The Problems of the Investment Advisor

Dreman notes that investment advisors and employed money managers suffer from institutional career pressures in addition to the individual cognitive biases previously discussed. These pressures and biases explain why professional money management and counsel has a less than stellar investment track record.

Often, working in an institutional setting means working in teams. Cohesive teams run the risk of falling into groupthink, which is a type of thought where members try to reach consensus by minimizing conflict and in the process not critically testing and evaluating the ideas thoroughly. As an example, if a research analyst continues to advocate out of fashion stocks to the detriment of his company's sales force, he will be creating team conflict. This pressure can cause team members to succumb to groupthink and in the process make poor investment decisions.

Being an investment advisor or money manager with clients causes another set of pressures. Often, clients second guess advisors. If an advisor stands firm against a client's opinion, for example on which investments to purchase, the advisor can lose the client. In a similar way, a money manager of a pension fund is going to be measured on quarterly performance results which means they always have to be in sync with the market. Since contrarian value investing methods can take considerably longer than a fiscal quarter to show positive results, a money manager will not usually be able to use these techniques. Increasingly, the pressure on institutional money managers will be to have investments in the "in vogue" stocks at exactly the right time.

Previous studies referenced in this book have shown the poor track record of professional advisors and money managers over time. It is concluded that career pressure and individual cognitive biases are contributing to this poor track record. While individual investors still need to be aware and exert control over human cognitive biases, they have a decided advantage against institutions as they don't have the same career pressures. As institutions have become increasingly dominant in the market, individuals are gaining an edge as investors with contrarian value investing techniques.

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