Liquidity and Emotion in Beantown
Oct 29th, 2008 | Filed under: Today's PostBOSTON – With the topic of liquidity weaving its way into nearly every session this year at this “unnamed hedge fund event” in Boston, you’d think that the institutional investors assembled here would want to be as liquid as possible right now. After all, wasn’t the recent market sell-off a result of forced selling of illiquid positions?
But not so fast…An informal poll of about 200 attendees revealed this morning that fully half of them believe that “investors should increase their allocations to highly illiquid investment strategies“. The poll was taken after a panel of pensions and endowments debated whether markets were “currently offering excessively high illiquidity premiums.”
Many hypothesize that the outperformance of university endowments (and some pensions) has largely been a result of their long time horizon and their resulting ability to lock-up their capital for eons to come. If the poll was any indication of broader sentiment, then it appears these investors haven’t been that phased by the recent flight to liquidity.
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“…Taffler has been busy interviewing 50 portfolio managers around the world with at least $1 billion under management. According to the professor, most of them concurred with his Freudian take on trading psychology. He told the gathering that investors operate in one of two modes: depressive (simply our normal and logical operating state – not “clinical depression”), and paranoid-schizoid (an aroused state where we basically ignore warning signs, then blame others for our travails).”
One practical application of these insights (for both investors and managers) is to ask yourself which of the following emotional states you are operating out of – A) I “want more” (roughly equivalent to aroused or even “greedy” OR B) I “want less” (roughly equivalent to cautious and the spectrum of uncertainty/doubt/anxious/fear). Using these two basic categories allows you to systematically integrate “emotion analytics” into your current processes.
Neuroeconomics research is delivering loads of data showing how our feeling states influence not only our decisions but our interpretation of data just as Taffler notes. (See Kuhnen and Knutson 2008 on Kuhnen Northwestern.edu website, Paper on Beliefs and “Affect”). In other words, as humans, we tend to see confirmation and not dissent in new data. Shiller mentioned this in yesterday’s NY Times Economic view column.
So in the tradition of psychoanalytic theory, it pays to put effort into becoming conscious of what one may be feeling and the simple more/less dichotomy above is an excellent starting point. That strategy yields three distinct benefits – #1 Realization of subtle bias #2) Direction on new avenues of focus #3) Higher levels of confidence in our analysis and our decisions.