Behavioral finance specialist Daniel Crosby, founder of newly minted firm Nocturne Capital, can’t help but feel frustrated with the way behavioral finance has been applied to financial planning.
In his view, the process has been limited to “good ideas poorly executed — or not executed at all.”
Crosby has spoken more times than he can count, he said, on the basics of behavioral finance as they relate to financial planning — patience, a long-term view, self-management, humility — only to cede the podium to a speaker whose focus is “chasing returns and reporting on short-term, relative performance.”
To break away from that, Crosby, author of the forthcoming book “The Laws of Wealth: Psychology and the Secret to Investing Success,” designed Nocturne to practice behaviorally informed investing “from top to bottom.” The firm’s products are designed for investors keen on socially responsible and values-based investing.
He spoke with ThinkAdvisor about the firm’s strategies and approach.
Savita Iyer-Ahrestani: What principles are your strategies are based upon?
David Crosby: At Nocturne, we take what we call “rules-based behavioral investing,” or RBI. We set out to design a process that is resistant to emotion, ego, bad information, misplaced attention and our natural tendency to be loss averse. No small task, but reflecting on what we know about human psychology, we understand that complex problems can have simple but elegant solutions. So we follow a streamlined process that helps mitigate behavior risk and combines the best of both active and passive approaches.
We do so by ensuring that our RBI process exhibits the 4 C’s: consistency (which frees us from the pull of ego, emotion and loss aversion while focusing on uniform execution); clarity (which ensures we prioritize evidence-based factors and are not pulled down the seductive path of worrying about the frightening but unlikely, or the exciting but useless); courageousness (which means we automate the process of contrarianism, doing what the brain knows to be best but the heart and stomach have trouble accomplishing); and conviction (helps us walk the line between hubris and fear by creating portfolios that are diverse enough to be humble and focused enough to offer a shot at long-term outperformance).
Recent research suggests that only about one-fourth of so-called active managers actually differ meaningfully from their benchmarks. We believe in active management, but only when it is truly active and accounts for the most pervasive human errors.
Iyer-Ahrestani: Please give us a few words about each of your core strategies and how they capitalize on investor misbehavior and mitigate fund manager bias.