Is Your Money Manager A Lunatic – You Had Better Hope So…

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By Andrew Hecht: Chief Market Strategist

  • Emotions- fear and greed drives the behavior of market participants
  • One study shows brain damage which prohibits emotions leads to better investing results
  • Systematic investment strategies operate without emotion
  • A systematic approach to markets
  • The Carden Capital Smart Hedge™ Index remains in cash

pst_jack nicholson


Volatility has been the name of the game so far in 2016 and there are lots of reasons that there is more on the horizon. Recently, Goldman Sachs told us that “the only thing to fear is fear itself” when it comes to markets. Jamie Dimon, the CEO and Chairman of JP Morgan Chase, gave markets a vote of confidence by using all of his 2015 compensation to buy JPM stock. I would argue that there are too many reasons out there circulating in markets to not have a healthy dose of fear these days. Actually, I believe the only thing to fear these days is not fearing the current investing and trading environment.


US Congress removed the word “lunatic” from any and all federal laws back in 2012 as the term had become “outdated” or “demeaning” according to the current wave of political correctness. However, there may be some compelling reasons that you want a “lunatic” or someone or something lacking a certain temperament, mood, personality trait or motivation managing your money. By the way, some of the characters I worked with in the trading rooms of Wall Street in the 1980s and 1990s surely qualified as lunatics. These traders were huge money makers and geniuses but their behavior, well, it bordered on making them certifiably nuts.


Emotions- fear and greed drives the behavior of market participants

Think of greed as a herd of stampeding animals all heading for the same food source at the same time. The fastest and most aggressive will eat the most; they are the greediest who will sate their glutinous appetites to the greatest extent. The slower animals will eat less, if at all. Now think of that same herd running from a predator that threatens their lives. Again, the fastest and most aggressive will likely survive the attack while the slow lumbering members of the herd will fall victim and wind up as prey. Like animals, market participants are wired to their emotions. Often these emotions get them into trouble.


So far in 2016, the fear factor in markets has dominated emotions for many market participants. We have all been told that huge market selloffs are an opportunity to buy because stock prices always come back. It sounds great in principle but in practice this is often a bitter pill to swallow. Each time we find ourselves in a situation where our nest eggs or trading capital is in a state of rapid decline, we find our stomachs turning and a green pallor coming across our collective faces.  It is fear and greed at its core; however, there are some studies that tell us that these are nothing more than wasted emotions and that market participants who do not succumb to them preform far better than the masses.


One study shows brain damage which prohibits emotions leads to better investing results

I recently read a study published in 20015 entitled Investment Behavior and the Negative Side of Emotion.  The results are fascinating. In the study conducted by psychologists connected with Stanford University, Carnegie Mellon and the University of Iowa, scientists looked at the investment choices and behavior between a control group and a group with “lesions in specific components of neural circuitry critical for the processing of emotions, which allow them to make more advantageous decisions than normal subjects when faced with the types of positive-expected-value gambles that most people routinely shun.”  In other words, those devoid of emotion tend to be better investors than the rest of us sad-sacks who experience the fear and greed deep within our psyches.


This got me thinking, should I find a money manager diagnosed with lesions in their neural circuitry for the processing of emotions to manage my portfolio or should I go another route?


All inappropriate and politically incorrect jokes about lunacy aside, there have been many stories and accounts published about hugely successful hedge fund and money managers that suffer from conditions such as Asperger’s Syndrome. Asperger’s affects the emotional reaction systems of those who suffer from the condition which may be a mild form of autism. An Asperger’s diagnosis just means that someone is wired differently than the norm and who knows what that is these days, anyway! Those suffering from this type of condition have had huge success in a myriad of disciplines. Financial acumen is just one of the career paths for successful people who suffer from Asperger’s.


In his book, The Big Short, Michael Lewis documents the brilliant hedge fund manager Michael Burry, who made hundreds of millions when the U.S. housing market and mortgage-backed securities market collapsed in 2008. Bury found out at the age of 35 that he suffered from Asperger’s. Lewis wrote, “The diagnosis explained an awful lot about what he did for a living, and how he did it: his obsessive acquisition of hard facts, his insistence on logic, his ability to plow through reams of tedious financial statements.” Burry himself has said, “Only someone who has Asperger’s would read a subprime-mortgage-bond-prospectus.” In all seriousness, I am not calling Burry or others afflicted with Asperger’s lunatics. They are different from the rest of us in that they do not have the same emotional reactions to stimulus.


Systematic Investment Strategies operate without emotion

Based on the established fact that emotion drives poor investing decisions, I only have two choices. One is to retrain myself to strip emotion from my own investment process. The other is to turn to a systems based approach and cede control to a system. If emotion negatively affects investment and trading results, why not totally remove it from the equation and interpretation of results.


While all systematic investment models are somewhat biased by the subjectivity of inputs and coding done by humans, the output is an objective response to those specific inputs. Computer models use input variables to generate output, a response that is without emotion but based only on those inputs. Therefore, other than finding a rare investor or trader like Michael Burry, a computer program or a systems based approach to investing may be the next best thing. In most cases, it may even be better in that there is absolutely no human bias.


A systematic approach entails collecting data and using technical and fundamental tools in order to predict market action using historical patterns as a guide. History tends to repeat itself and market divergences tend to correct and revert to means over time. Therefore, patterns and price behavior observed and evaluated in a non-emotional environment are effective. These systems often yield results that outperform market indices and the human behavior of the smartest and most clued-in traders and investors.


The Carden Capital Smart Hedge™ Index remains in cash

Markets are currently enveloped in fear. That is why we are seeing declines in stocks and many other assets thus far in 2016. The only markets that have moved higher through the first two months of the year are high quality government bonds and precious metals. This clear flight to quality is a sign of the fear that remains prevalent in markets in the United States and around the world.


The Carden Capital Smart Hedge™ systematic signal switched to cash on December 11, 2015 when the S&P 500 index was trading at 2,012.37. Today on February 29th, the S&P 500 closed at 1,932.23 — a decrease of 4.0%. The index remains in cash and volatile market conditions promise to remain until certainty and stability returns. This is an example of a systematic index that is devoid of emotion as it operates through a system of data inputs and pattern recognition dating back decades minus the emotional aspects that can skew results.


Money managers or traders without emotional boundaries are a rare commodity indeed. At Carden Capital we do not believe it is possible to remove emotions entirely from our investment process.  Therefore we focus on systematic models that are meticulously tested and designed to offer superior risk adjusted returns.


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