Essentia Analytics (Essentia), a leading provider of behavioral data analytics and consulting for professional investors, today made available in-depth analysis of how active equity portfolio managers (PMs) behave when experiencing a Winning or Losing Streak and the impact any behavioral change has on performance. Revealing that half of PMs change behavior during either type of Streak, the results of the study are captured in a white paper titled “Holding the Line,” which Essentia presented at its second annual Behavioral Alpha summit last week.
Leveraging anonymized data from its client base, Essentia analyzed trade and holdings data from 29 active equity portfolios across 21 different firms, including five hedge funds, located in North America, Europe, and Asia, spanning 2008 to the present. The data equates to 250,000 trades and 3.5 million individual data points, overall. Drawing from behavioral research, particularly in the areas of sports and gambling, Essentia defines a Winning Streak as any sequence of five days in which fund profit was positive on each day and a Losing Streak as any sequence of five days in which fund profit was negative on each day.
Notable findings of the study analyzed in “Holding the Line” include:
- Half of the active equity portfolio managers in the sample showed some change in behavior after experiencing a Winning or Losing Streak – nearly a quarter changed it when winning and 41% changed it when losing;
- Those who changed their behavior while on a Winning Streak tended to reduce turnover via making fewer decisions;
- Managers on Winning Streaks made worse decisions, but it didn’t have a major impact on performance because they traded less;
- Over one-third of all managers significantly increased their turnover, through a combination of bigger clips and more trades, when they were on a Losing Streak;
- Managers on Losing Streaks made worse decisions and that had a significant impact on performance;
- Thirty-five percent of managers tended to destroy 2.3bps of portfolio value during either type of Streak.
“If you ask most fund managers or traders whether they behave differently, vis-a-vis investment decision-making when they are on a Winning or Losing Streak, they will say ‘probably.’ However, very few could tell you exactly how their behavior changes, or whether the quality of their decisions actually improves or deteriorates,” said Clare Flynn Levy, founder and CEO of Essentia. “Our aim in sharing the results of this analysis — which notably looks at a 10-year period when the world changed dramatically, but market volatility remained relatively low – is for portfolio managers to actually put the insights to work and make more informed investment decisions.”
In looking at behavior during a Streak, Essentia considered three dimensions: turnover (in portfolio currency terms); average trade weight (what might be termed average ‘clip’); and the number of trades per day. Return on investment and the profit contribution of those trades to the overall portfolio value over a forward time period were then factored in to determine the impact of changes in behavior on performance. The empirical results summarized in the paper suggest support for prior behavioral research including the Illusion of Control and increased risk seeking behavior in the domain of losses (Kahneman & Tversky’s Prospect Theory).
In addition to the empirical results, “Holding the Line” includes a detailed breakdown of specific behavioral activity during Winning and Losing Streaks, including Portfolio Turnover, Number of Decisions, Trade Size, and Decision Quality, with accompanying charts and graphs. The white paper may be downloaded here: www.essentia-analytics.com/holding-the-line/