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Harnessing Behavioral Factors in the Investment Process: Behavioral Factors for Picking Equity Managers and Stocks

Published on October 14, 2019

Investments & Wealth Monitor | September/October 2019 Issue


Abstract

Behavioral finance is sweeping through the financial services industry. Financial advisors are the furthest along, introducing these concepts into their practices, including needs-based planning, outsourcing non-core activities such as investment management, and creating a reassuring behavioral experience for clients.

The advisors who have made this transition, according to a recent report by Cerulli Associates, grow faster and end up with wealthier, more loyal clients.1 Such a transition allows advisors to provide client value relative to their robo-advisor and index fund competition, as confirmed by Vanguard, Russell Investments, and others.2 Howard and Bunker (2018) provide a blueprint for transitioning to this type of advisory model.

Active equity investment managers face a challenge not unlike that faced by advisors, with large outflows over the past 10 years, roughly matched by low-cost index fund inflows. Active equity must deliver value relative to index offerings. I believe the best way to accomplish this is to harness behavioral factors in each aspect of the investment process, similar to how successful advisors have incorporated behavioral factors throughout their practices. Some of the material in this article is drawn from Howard and Voss (2019).