“The crazy thing is thinking humans act logically all the time.”
This is a quote from Richard Thaler, the founding father of behavioral economics, which he uttered in his cameo in The Big Short and is set in stone, so to speak, in the About section of the Fuller & Thaler Asset Management, Inc. website; the investment firm founded in 1993 by the Nobel prize winner in economics (quotes around “Nobel”). Fuller & Thaler aims to leverage flaws in the intersection between psychology and economics to propose a new investment philosophy, based on the cognitive biases of investors acting in the market.
Despite increasingly zealous work, 30 years after Fuller & Thaler was founded, the principles of behavioral finance still remain a marginalized concept. And a good example of this is that the young MAPFRE AM Behavioral Fund turned one and a half years old as Europe’s only behavioral finance fund.
We interviewed one of its managers, Luis García Álvarez, to find out more about his career and the fund he manages.
How did you develop an interest in behavioral economics?
I first developed an interest in Economics when I had to decide which direction I wanted my studies to take. And so, within this first step, I embarked on a more quantitative academic education in economics. Then, during my Master’s degree and my first few years of work, I read books, attended conferences, and at one of those conferences, I met someone who recommended Thinking, Fast and Slow by Daniel Kahneman. One book led to another, one conference led to another, and that interest in behavioral economics, and more specifically behavioral finance, kept on growing.
Would you say that the psychological aspect is still somewhat lacking in Economics education?
Absolutely. And even more so in Europe. Traditional economics is still largely dominant, and efforts must be made to try to give behavioral economics the inclusion it deserves, slowly but surely. In recent years, we have been fortunate enough to have several behavioral economics researchers become prizewinners of the so-called Nobel prize in economics, which has been a great source of momentum. But this momentum has not yet translated clearly into how subjects and the major in Economics are designed at universities.
In fact, this was one of the reasons that led us, together with ICADE University, to launch the executive program on value investing and behavioral finance, which explicitly includes behavioral finance in the program design.
Who have been your influences in the field of behavioral finance?
Perhaps the person who helped me take that first step and enter the world of behavioral economics specifically — Pedro Bermejo, a Spanish neurologist at the Hospital Puerta de Hierro de Majadahonda becoming increasingly more recognized, and author of books such as El cerebro del inversor (The Investor’s Brain) and Neuroeconomía (Neuroeconomics).
It’s Pedro who has been guiding me and giving me reading recommendations, and, by following his lectures, I have also learned a lot particularly about the most scientific part: how our brain works, how it is designed. This structure, which is the most complex structure in the universe, developed in a few years when humans were preoccupied with their survival, not with their finances. Now, a long time later, we have to make decisions that relate to our money and that, by definition, have a very high emotional component, which makes our biases much more active.
Another influence of mine, who is also Spanish, is Pedro Rey Biel, who, like Pedro Bermejo, is also a good friend (both are members of the MAPFRE AM Behavioral Fund advisory board). In my opinion, Pedro Rey Biel is also one of the leading figures, not only in Spain, but also throughout Europe. I’ve been learning a lot from what he has posted on his blog Nada es gratis (Nothing is free).
How would you define what a behavioral fund is?
In short, it is a fund intended to use psychology findings to understand how investors make decisions. Within this is the first European fund to wave the behavioral finance flag. With reference the US system, there are two types of behavioral funds:
• Automated funds, which use behavioral economics criteria to further automate investment decisions.
• Other funds, which mix behavioral finance with fundamental analysis.
We are in this second group. We always say that behavioral finance draws our attention to any gaps in the market, but our strength—and what we always rely on—is a fundamental in-depth business analysis.
We look for those companies that we think have a business that will be most resilient in the coming years, that have a good balance sheet and a good management team behind them, in which we can trust.
What are some of the most frequent biases involved in behavioral finance?
In the investment world, all biases—of which there are many—can be grouped into two broad categories: Those that cause an overreaction to negative news and those that cause an underreaction to positive news.
While negative news travels fast in the investment world and we tend to react sharply and quickly, we react to positive news somewhat inversely. As investors, we generally take a while to incorporate this information.
There are many other biases beyond that.
Some of the most recurring biases may be the herd mentality, whereby those who work in the investment world all move together so that we feel more comfortable as a group. This is something that brings us comfort and well-being, but it doesn’t help us conquer the market, which is what our clients pay us to do.
Or other biases, such as the endowment effect, whereby once you are an investor in a company, you tend to think that said company is worth much more than it is.
How would you summarize the fund’s first year?
It has been a year of learning that has been accepted very positively by investors. But one thing we always say is that the overview will come later; one year, two years or even three years is not enough to evaluate the investment decisions that have been made.
This year and a half, we have had periods of great return and periods of poor return or return that hasn’t been as high. But these investments need to be assessed over the long-term to determine whether we were right or wrong.
Over this year and a half, we have taken a closer look at our investment process, refining detail and further developing the way in which behavioral finance can help us make better decisions.
And how has it been received by the community of investors, academics, etc.?
Really well. From our sales network—which I think has really appreciated having a different product—to the academic community, and even other institutions, which we also know are looking into this and have already begun to incorporate behavioral finance into either their strategies or into their communication with clients.
And even within the institution itself, our own company, we are very happy with how this has been received and the support we have felt.