Last Updated on 10 February, 2024 by Abrahamtolle
The financial markets are dynamic ecosystems where market participants, including institutional investors, continually make decisions that shape investment portfolios.
This article delves into the research paper titled “Selling Fast And Buying Slow: Heuristics And Trading Performance Of Institutional Investors” by Klakow Akepanidtaworn, Rick Di Mascio, Alex Imas, and Lawrence Schmidt, which explores the decision-making processes of institutional investors and their impact on trading performance.
The study focuses on the intriguing question of whether market experts are susceptible to heuristics and how these cognitive biases manifest in their buying and selling decisions.
Methodology Used in The Research
The research utilizes a unique dataset comprising 783 institutional portfolios, with an average value of $573 million. The portfolios are managed by experienced institutional portfolio managers (PMs), hired by single institutional clients like pension funds. The dataset spans from 2000 to 2016, providing a comprehensive view of daily holdings and trades.
The study evaluates performance by constructing counterfactual portfolios and comparing the actual decisions of PMs to returns of counterfactual strategies. Notably, the dataset allows for the evaluation of selling decisions relative to a conservative counterfactual, assuming no skill, i.e., randomly selling an alternative position not traded on the same date.
The institutional sample comprises portfolios managed by PMs, and the data are compiled by Inalytics Ltd. These portfolios are long-only equity portfolios, mostly tax-exempt, internationally diversified, and hold limited cash. The PMs in the sample are active managers hired by institutional clients to generate alpha through concentrated portfolios.
The portfolios are characterized by high conviction and large tracking error budgets, indicating a departure from benchmark strategies.
Key Findings of The Study
The research paper presents compelling insights into the decision-making processes of institutional investors. The key findings of the study can be summarized as follows:
1. Asymmetric Performance in Buying and Selling
The study reveals a notable asymmetry in the performance of institutional investors when it comes to buying and selling decisions.
There is clear evidence of skill in buying decisions, where institutional investors demonstrate the ability to outperform counterfactual strategies.
2. Substantial Underperformance in Selling
In contrast, the research uncovers a striking finding: selling decisions systematically underperform, even when compared to random selling strategies.
The magnitude of underperformance in selling is substantial, with an average loss of approximately 80 basis points at a one-year horizon relative to a counterfactual strategy of random selling.
3. Heuristic Processes in Selling
The study suggests that the observed underperformance in selling can be attributed to the use of systematic, costly heuristic processes.
Institutional investors tend to employ heuristics specifically when selling, contributing to the discrepancy in performance between buying and selling decisions.
4. Attentional Allocation and Cognitive Resources
The research proposes an explanation for the observed asymmetry, emphasizing an asymmetric allocation of cognitive resources.
Institutional investors focus more on buying decisions, allocating fewer cognitive resources to the selling domain. This bias leads to the use of heuristics in selling decisions.
5. Influence of Portfolio Characteristics
Heterogeneity in performance is identified across different types of portfolio managers. Fundamentals-oriented managers with highly concentrated portfolios and higher tracking errors exhibit more pronounced underperformance in selling.
The nature of the portfolio and the investment style play a role in shaping the effectiveness of heuristics in decision-making.
6. Implications for Learning and Decision-Making
The study highlights the importance of frequent and consistent feedback for learning. However, it notes that reporting standards are better suited to identify underperformance in buying decisions than in selling decisions.
Theoretical frameworks suggest that institutional investors may fail to recognize their underperformance in selling due to an imbalance in feedback.
7. Potential for Improvement through Decision Aids
The study suggests that the adoption of decision aids or alternative selling strategies may significantly improve the overall performance of institutional investors.
Creating environments that facilitate effective learning, such as through amended reporting standards, could contribute to more informed decision-making.
8. Selling on Earnings Announcement Days
Results indicate that selling decisions on earnings announcement days perform significantly better, suggesting that when decision-relevant information is salient and readily available, selling performance improves.
In conclusion, the research paper sheds light on the heuristics and trading performance of institutional investors. The study provides valuable insights into the asymmetry between buying and selling decisions among experienced PMs, highlighting the presence of cognitive biases in the decision-making process.
The findings have implications for understanding how attentional allocation and heuristics contribute to the overall performance of institutional portfolios. The article underscores the importance of creating environments that facilitate effective learning and decision-making, ultimately improving the performance of institutional investors in the financial markets.