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Herding, Performance Chasing and Committee Structures: The Three Maladies of Institutional Investing - Opalesque Roundtable

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Particularly since the global financial crisis, institutions find that they have more or less made the same investments with the same, brand name managers. How could such a level of herding have happened? Which investor groups have invested differently, and how and why?

The other malaise that affects investors more often than not is performance chasing. If you go beyond the surface, investors' reasons to invest or not to invest with a certain manager in many cases boils down to chasing past performance. Often the investor is both not conscious about it, and also not equipped with the proper know-how and procedures to invest rationally.

For most institutions, the rate of return (even risk adjusted) is not the only criterion for making an investment. If you look more closely, there are many different utility functions that come into play, like adjusted career risk, or the element of second guessing, particularly in committee-based investment decisions in large, complex organizations. This is totally understandable – there has been a lot of stress in these organizations over the last four or five years: many people have lost their jobs, and the usual organizational reshuffling and uncertainty creates stress and nervousness:

“You have this individual responsible for manager selection. His job is to recommend a new investment opportunity to the CIO. He does not want his recommendation to be rejected, so he will second guess the CIO’s reaction and recommend the manager that, in his opinion, is most likely to be accepted. That means he is not only evaluating the manager, he is also evaluating or anticipating the reaction from the CIO. And the CIO in turn may be second guessing the investment committee who may be second guessing the board of directors, who is second guessing the media and politicians they are responsible to. So everybody is second guessing up the food chain, and that is normally not the best way for rational decisions to be made”, says RPM's Mikael Stenbom.

This second guessing theory may also help explain why established managers with lots of assets under management tend to perform at best averagely, because they also have that committee structure internally. In fact, studies showed if you bring a question to a group of individuals, and then contrast their decision – as individuals – against a committee, the result the group comes up with typically underperforms the average result of the individual decisions.

The Opalesque 2013 Nordic Roundtable was sponsored by Estlander & Partners, Eurex and Taussig Capital and took place in September 12th in Stockholm with:

  • Martin Estlander, Estlander & Partners
  • Mikael Stenbom, Risk & Portfolio Management (RPM)
  • Peter Seippel, Optimized Portfolio Management (OPM)
  • Karl Trollborg, Wassum
  • Joe Taussig, Taussig Capital
The group also discussed:
  • What is the demand for and the current use of alternative investments by Nordic investors?
  • How relevant is Solvency II for investors? Why is IFRS a challenge for institutions?
  • To what extent does modeling work? Why is “physics’ envy dangerous to your wealth”? To what extent should correlation assumptions play a role in proper risk management?
  • How can asset managers keep innovating?
  • Why the organizational distance between the actual owner of capital and the decision maker about the investments determines if the investment decision will be conventional or not
  • In which phase of an asset manager's corporate life cycle should you invest in him?
  • The evolution of the CTA industry: what's coming after Transtrend, AHL, Winton, or Aspect?
  • Why many managers will in fact choose not to comply with the AIFM directive, and instead go for the UCITS fund format solely.

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