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Common Biases Of Goalkeepers And Portfolio Managers

Penalty kickMillions of fans around the world have tuned into to this year's World Cup in Brazil. And whether you love it or hate it, the penalty kick is one of the most exciting plays in football. As the striker approaches the ball, often with the outcome of the game hanging in the balance, the goalkeeper has a split second to decide what to do, making it not unlike the plight of portfolio managers in today’s fast paced market.

Dive left? Dive right? Stay standing in the center between the goal posts? The odds aren’t good: fewer than one in five penalty kicks are ever stopped at this level of play.

Stayed At Home

In 2006, the World Cup Final between Italy and France came down to a penalty kick shootout. On the first kick, the French goalie chose to dive to his right. However, the shot from the Italian striker went straight down the middle. Had the French goalie stayed at home, the outcome of that shot, and perhaps the game, may have been different.

According to one study, goalkeepers choose to dive nearly 94 per cent of the time.1 In response to the relatively even distribution of kicks between the goalposts, however, and the greater chance of saving those in the middle, goalkeepers who stand and defend the centre may experience a better outcome. Simply put, not taking action may be the best course of action.

Due to what behavioural researchers call ‘action bias,’ a goalkeeper is expected to act. In the case of a penalty kick, the norm is to dive. A scored goal is perceived to be less disappointing when it follows action. Innate self-confidence, years of training, and the crowd’s expectations further contribute to this sub-optimal decision. If the goalie dives, then he feels that he did his best to stop the ball, and so does almost everyone else.

Investment managers often fall into the same trap of action bias — trading frequently, with confidence that this action adds value. And whether the trades ultimately prove to be right or wrong, the manager who trades frequently looks like he's doing something to generate results. This is one of many behavioural traits contributing to widespread short-termism in the markets.

In recent years, the average holding period for a stock has dropped to about seven quarters.2 All too often, the concept of buy and hold investing has been subsumed by short-term trading strategies. Many of these trading strategies, which rely on top-down macro-economic calls, are often no better at predicting the future direction of the market than the goalie who tries to guess which way the shot is going.

Such a short-term bias creates an enormous time-horizon arbitrage opportunity for individual and institutional investors who are willing to take a long-term view. Over very short time periods – say, one week – the average difference between the best- and worst-performing stocks usually comes down to a few percentage points. Move out to one-year and you will begin to see stocks that significantly outperform in any given year. However, as they say, there is no free lunch and many of these high-flying stocks will often see market sentiment turn against their lofty valuations and find themselves at the bottom of the league tables the following year.  

Quite Meaningful

By contrast, if you look at the performance dispersion between the best and worst stocks over a five-year period, the numbers becomes quite meaningful. Simply put, over the long-term, the cream rises to the top, with the top 10 per cent of stocks outperforming the bottom 10 per cent by over 160 percentage points.3 And a common thread among managers who consistently generate long-term results is a strong buy-and-hold mentality. Managers who look to invest in companies that are well-positioned to generate growth over multi-year time periods have the courage to do nothing when short-term trends and negative headlines have the traders running for the exits.

Portfolio managers can lengthen the investment horizon by avoiding the temptation to trade frequently, choosing instead to hold securities for longer periods. Though portfolio managers – and goalkeepers – are prone to act, an awareness of this action bias may help them recognize that inaction can be an optimal strategy.4 And deciding to hold the position has the potential to result in a better outcome for their clients – and fans.

Mariana Araujo is a Sao Paulo, Brazil-based equity research analyst for MFS Investment Management.

1. Bar-Eli, Michael, Ofer H. Azar, Ilana Ritov, Yael Keidar-Levin, Galit Schein, ‘Action Bias among Elite Soccer Goalkeepers: The Case of Penalty Kicks,’ Journal of Economic Psychology, January 2007. According to this study, kickers distribute shots much more equally across the left, centre, and right thirds of the goal. The authors suggest that if goalkeepers altered their strategy to stay in the centre, then kickers might adjust and send more shots to the left or right.
2. Ned Davis Research, December 2013
3. MFS, ‘Lengthening the Investment Time Horizon,’ May 2014
4. Montier, James, ‘Mind Matters: Beware of Action Man,’ Société Générale, 7 January 2008

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