A few years ago, Robert Bridges, executive director and co-head of Sterling Capital Management’s behavioral finance equity group, took a long look at the airline sector. Bridges had never been totally convinced of the sector’s merits, and ultimately, after much deliberation, he decided to pass.
That wasn’t the best investment decision at the time, he admits.
“I didn’t go into airlines because I had a bias against the sector, but it became clear that there was still value left there,” he says.
That’s why Bridges and his team at Sterling make as conscious an effort as possible to steer away from their own cognitive biases to make sure they don’t get in the way of potential value in any sector or stock. However, their behavior-focused funds capitalize on the biases of other investors — biases that, regardless of investors’ financial sophistication, unwittingly condition their investment decisions.
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These biases — and Sterling believes that fear, greed and ego are the most important — create irregularities in the market, Bridges says, which in turn create value and momentum.
“We’re trying to capitalize on fear, greed and ego at all points in the cycle,” he says, “and the key to that process is a framework that identifies and captures valuation and momentum anomalies.”
Investors’ fear of “bad” stocks, Bridges says, creates value. Their greed drives them to “chase what works,” and that means holding onto losers longer than necessary in order to avoid realizing losses while selling winners too soon, a dynamic that creates momentum. Finally, financial analysts tend to be overconfident in their ability to forecast the future, he says, even as they’re slow to react to new information; then they’re quick to play catch-up once they realize their mistake, their ego resulting in earnings revisions.