Describe the Ways That Jp Morgan Is Using Behavioral Financ

Quinn Drinan: JP Morgan Behavioral Finance: M/W @ 9:30

1. Describe the ways that JP Morgan is using behavioral finance.

The Asset Management unit at JP Morgan had been known as being a pioneer in what it termed “Behavioral Investing.” In other words, when they buy on emotion, and not perfectly rational investments, their investment plans can be exploited, and also creating opportunities for others in the market.  JP Morgan’s behavioral investing strategy had 5 products that they offered, and each product were in the top 20% of their Lipper categories.  Richard Chambers, the head of U.S. and European marketing, gave investor psychology a central role in branding of the new fund (or “products”).  His idea was that well documented behavioral biases could create opportunities for JP Morgan’s investment managers and seemed to resonate with retail investors.  Many different asset managers used this investing principle for competing funds, but a majority did not embrace psychology and behavioral finance in the retail market.  JP Morgan was the outlier, and they marketed their slightly different strategy to investors to separate themselves from competing firms.  Under this philosophy, JP Morgan managed more than $76 billion in behavioral strategies worldwide by the end of 2006.

JP Morgan uses behavioral finance by using analysis and empirical research to find specific trends in stocks that lead to outperformance.  This approach is different from traditional finance in the way that prices should be accurately priced.  JP Morgan’s behavioral approach believed that prices were priced for different reasons, and therefore, could be exploited for greater returns.  JP Morgan emphasized two behavioral biases: overconfidence and loss aversion (with recency and anchoring becoming more popular).  Portfolio managers of these funds believed both were pervasive and persistent in influencing investing decisions and key to explaining the existence of value and momentum anomalies.  Each bias was grounded in psychology, with an application to financial decisions and an implication for stock prices.  In terms of overconfidence, Complin believes his approach forces their funds to systematically overweigh value stocks, which means that their investment behavior is changed.  They are forced to focus on out of fashion stocks that they would not naturally have bothered with and that means they cannot fall into the same overconfidence trap.  Also, momentum investing works because stocks don’t immediately reach a new price warranted by the information they have just released, as investors’ disposition effect slows down the direction of stocks, either way. Their approach requires a systematic tilt to momentum, forcing them to run their winners and cut their winners, something rational (loss averse) investors do not.

Complin believed that nothing other than human behavioral biases can explain why value and momentum stocks have outperformed for 55 years.  The basic tendency to be overconfident, to seek pride and avoid regret was there 50 years ago and it will be there in another 50 years.  In theory, this means that, provided JP Morgan doesn’t change their investment processes, they will still be outperforming in 50 years time.

1. What is the investment philosophy of the Insight funds? What is their logic and how is it implemented?

JP Morgan’s investment philosophy of the Insight funds can be pictured by Golub’s graphs of standard deviation (risk) vs. total return (%).  Traditional finance theory shows that taking on additional risk, an investor will be compensated by more return.  However, stock market data over the past 20 years shows the opposite, where total return decreases with additional risk.  Complin and his team believed that this irrational behavior led to market anomalies that could be exploited with a discipline trading approach.  This investment philosophy for Complin was started after empirical evidence from both academic and practitioner studies showed that stocks with specific characteristics had outperformed, consistently, over time.  More specifically, cheap stocks outperformed expensive stocks over the 55 years ending in 2005.  Additionally, the best recent performers had outperformed the worst recent performers.  Golub believed these anomalies were glaring, and that outperformance cannot be explained by risk.  Rather, he believed that outperformance is the collective impact of human psychological biases on markets.

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