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INSTITUTIONAL INSANITY

Mark Northwood – Consultant at Bips Global discusses why

Too many investment firms are still repeating the same mistakes…

There is virtue in being consistent. It suits certain processes, such as where the goal is an end product with minimal variation like a phone or a fizzy drink. Institutional Investment is a tricky business though, and while most institutional investors describe their “investment process” as if it were sticking to a fixed set of rules to make decisions, there are still human analysts, portfolio managers (PMs) and traders involved too. And humans are, well… human.

Over 20 years running trading desks within large asset management firms, I have seen each individual PM or trader follow an investment process, which includes common human behaviours (some good, some bad), and these are repeated over and over again. Even simple analysis of the data reveals the existence, and impact of these repeated behaviours through time.

One example is where portfolio managers look for “price confirmation”, which is basically waiting for prices to rise before buying a stock. I regularly modelled this behaviour for PMs, to show that it leads to a predictable, ongoing under performance against the market or benchmark, which can easily be 1-2% for funds with higher turnover. That is a big loss to make up elsewhere. Traders also exhibit risk aversion behaviours, which cost their investors a little money every day, which also adds up to a lot. And yet there continues to be widespread resistance to adapting, to making carefully researched changes to improve the results.

For people trusted with other people’s money, and employed in such a competitive industry, that surely qualifies as institutional insanity?

I should acknowledge that there are many exceptions to this institutional insanity, such as genuine quantitative investors and some progressive asset management firms, where data analytics and a continuous performance feedback loop are cornerstones of the process.

The better news is that institutional insanityis easily treatable – actually, using tools which borrow from the science of drug trials. One such tool is “Strategy Builder”, developed by Trade Informatics, an award winning analytics provider, and a key reason why Bips Globalworks with them. This optimisation engine is very good at looking backwards to work out how to do things better going forwards. It then tracks changes rigorously to make sure they actually work. Anything less is bad science.

Given how accessible these tools are now, it is also institutional insanity to not be using them.