/ 22 June 2009

Emotional investment

When Wall Street guru Jim Rogers warned with almost frightening accuracy in 2007 that the international stock markets were in for a major collapse and gave his reasons, his foresight was treated with little more than a sceptical smile.

Rogers had his own set of rules and warning signs regarding stock markets, based on his own and others’ research into investor psychology.

The warning signs were obvious, he told Fortune magazine in December 2007. ‘You see 29-year-old kids making $10-million or $20-million a year and thinking: ‘This is the way the world is. This is normal.’ Well, I don’t think it’s normal.” There were other red lights flickering as well: the so-called aspirin index, a not-so-scientific but quite effective way of predicting stock market behaviour.

Aspirin sales were climbing vigorously, indicating worried investors’ growing headaches. The subsequent economic crisis and its ripple effect on the world have underscored the importance of more research in the field of behavioural finance.

In South Africa the Institute of Behavioural Finance (IBF) was recently formed to focus on the study and research of behavioural biases and their effects on financial markets. IBF chief executive Professor Zac Nel says behaviour finance is, in essence, the study of how investors interact and act on information when making investment decisions. ‘It is normally closely related to behavioural economics and attempts to explain investor behaviour or market anomalies when rational models provide no sufficient explanations.”

But this analysis does not replace traditional financial prediction models. ‘It rather tries to improve existing models by incorporating more realistic assumptions,” says Nel. Researchers have established that people are willing to take more risks to avoid losses than to realise gains.

Faced with sure gain, most investors are risk-averse. Faced with sure loss, investors become risk-takers. Pieter van der Merwe, coordinator of the field of investor psychology at Unisa’s College for Economic and Management Sciences, says: ‘A different set of rules takes over when an investor panics. ‘People are not accustomed to thinking hard and are often content to trust a plausible judgment that comes quickly to mind rather than reason out a complex decision.

Led by an irrational decision process, wrong decisions are therefore taken. That is why the markets always overreact upwards or downwards. It’s all about emotional weaknesses, triggered by a condition of investor anxiety,” he says. Dr Richard Geist, Harvard University psychologist and editor of Strategic Investing, says that emotions influence investment decisions.

He says that intuition is wrongly used to size up a situation without being aware of the past experiences with which it is being compared. These experiences are nearly always tinged with emotion, he says, and it is frequently those effects that are embedded in our unconscious memories that are subtly evoked in the present situation.

Concerning stock market predictions, they are often intuitively based on past emotional experiences that are rekindled by similar, but slightly different, feelings in the present. These predictions are always couched in hyper-rational terms because otherwise they wouldn’t be believable.

The importance of making some sense of what shapes the actions of investors was why Unisa launched a course in investor psychology nearly three years ago –the first South African university to do so.

Based largely on the prospect theory of Daniel Kahneman, professor in psychology at the Princeton University in the United States and a recent Nobel prizewinner for economics, the six-month module uses psychology to explain so-called anomalies that we observe in the financial markets –apparent mispricings and inefficiencies that are not consistent with the classic economic models of rational behaviour.

Van der Merwe, who also lectures on investor psychology as part of the annual actuarial induction programme of the Liberty Group and who is working on a doctorate on a related subject, says that investor psychology research is still limited in South Africa.

‘However, research will probably reach top gear, driven by the awareness that there are more factors involved in an investment strategy than meets the eye –for example, the role of sensory intelligence. The era of holistic decision-making has arrived.”

Biologists get European boost
Molecular biologists in Africa will be able to tap into greater resources after South Africa was granted associate membership of the European Molecular Biology Organisation (Embo).

The membership, announced earlier this month, is the first for an African country and follows five years of discussions. South Africa will have access to core Embo activities and programmes, such as fellowships, courses and workshops. Iqbal Parker, director of the Cape Town branch of the International Centre for Genetic Engineering and Biotechnology, told Higher Learning that South African-based scientists can apply for grants previously available only to scientists working in Embo’s 25 European member countries.

The closing date for this year’s applications is September. Flexible long-term fellowships, most beginning in January 2010, ‘will allow South African-based scientists to apply to work at institutions in other Embo countries”, said Parker, who was a major driver of the agreement.

‘Short-term fellowships will enable masters, doctoral and post-doctoral students to learn new techniques at Europe’s top institutions,” he said. Some practical training courses organised locally, but funded by Embo, have already been run in South Africa in anticipation of this month’s membership approval.

Although no other African nation is in the pipeline for membership, the practical training courses in South Africa are open to scientists from across the continent. ‘For most African scientists attending training courses in Europe is out of the question because of cost, time and visa administration hassles.

Hosting these courses in South Africa encourages more scientists from throughout the continent to participate,” said Tsungai Jongwe, a molecular biology master’s student at the University of Cape Town.”And there are many scientists from other African nations studying and working in South Africa, so they will benefit as well,” said Jongwe.

Hermann Bujard, executive director of Embo, said the agreement includes provision for European scientists to visit South Africa to give them ‘insight into the magnitude of problems on the African continent. South African scientists will be empowered to employ the latest scientific advances to benefit their own communities.”–Carol Campbell, SciDev.Net