Improving Decisions to Evolve beyond Passive Management


“Personally, it would be a lot of fun to be a portfolio manager in a world where 80% of the market was indexed, because there would be huge liquidity with dumb money.”

— Richard H. Thaler

Index funds have disrupted the status quo and passive strategies are expected to play an increasingly large role in the investment industry’s future. Yet some observers, like Nobel laureate Richard H. Thaler, think that future will be full of opportunities for active investment managers.

At the 70th CFA Institute Annual Conference in Philadelphia, Thaler pointed out that an environment dominated by passive indexing strategies holds greater opportunities for the smaller number of investors who remain active.

The question facing today’s portfolio managers is how they can survive long enough to see that future.

Josh Brown, CEO of Ritholtz Wealth Management and author of The Reformed Broker, has noted that marketing, advertising, and established reputations are no longer enough for asset managers to attract and retain clients. He thinks the investment firms that endure will be those that adapt to disruption by examining their processes carefully and improving how they make decisions.

Decision strategist and world poker champion Annie Duke works with traders and other investment professionals trying to improve their performance. She feels that human decision makers still bring unique strengths to the investment process, despite technological advancements like artificial intelligence (AI) and machine learning that are disrupting the investment landscape.

Investment professionals who identify and develop those unique strengths can clearly demonstrate their value. “A portfolio manager or trader who is willing to embrace technology, and who is willing to reflect objectively on what is working and not working about the investment process, has a competitive advantage,” Duke observed.

Clare Flynn Levy, founder of Essentia Analytics, has also recognized that active investment managers face increased pressure to prove their value. She has written that there may no longer be a competitive advantage to having access to better information, but excess returns can still be generated by focusing on self-improvement more than your competitors.

One of the ways that investment managers can accomplish this is by identifying and correcting the unconscious changes in behavior that sabotage their performance. Flynn Levy’s firm has researched the behavior of portfolio managers after experiencing a string of gains or losses: Nearly a quarter of the active portfolio managers studied shifted their behavior following a profitable streak.

If these investment managers had a decision-making process that was generating positive returns, why would they change the formula?

These are the types of questions that must be answered by those who want to succeed in active management. “I believe that there is skill in active management, that there are going to be active managers — just fewer of them,” Flynn Levy said. “If you want to be one of those, you’ve got to play at a different level.”

At the 72nd CFA Institute Annual Conference in London, attendees will have an opportunity to develop their skills with a Flynn Levy-led session on applying behavioral finance to the investment process, along with educational tracks exploring such topics as machine learning and AI.

Register today to hear valuable ideas from noted economists, best-selling authors, leading researchers, and successful practitioners.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: NASA

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