search strategies for value investor - the anomaly of value (3)
As powerful as the funds are in the stock market, they are run by human (i.e. money managers). Greenwald et al. tried to explain why, if the money managers were not guided solely by reason and evidence, enduring biases that are going to be discussed below may create investment opportunities that should not exist.
His explanation is based on the fact that money managers are also employees hired to produce results by prescribed investment policies. For job security, it makes sense for them to strive to keep average performance instead of making smart move. The reason is simple. If the exceptional move unfortunately turned out to be bad, this record could tarnish the manager reputation which as a result negatively affects the future career. This consequence is severe. So, the money manager interests or agendas may possibly not be in line with the interests of the institutions they work for.
Money managers may follow a herd mentality. The rather loose definition of "herd mentality" is when various money managers seemingly all invest in the same stocks. Of course, the reasons why money managers herd may actually be much more varied. Some said money managers herd on the sell side for the fear of falling stock price, while another found that low transparency of relatively small and growth stocks can also be the reason why money mangers herd. Andrew Koch who has done the research on "herd behavior and mutual fund performance” supports Green et al. arguments. The research results suggested that managers who make similar investment decisions as the others do so for non-informational reasons. The evidence is consistent with a career concern explanation. Regardless of the reasons why the money managers herd, this behavior does create opportunities for value investors to pick up the undervalued stocks.
To avoid poor performance, money managers may window dress their portfolios, dumping the stocks that have fallen in price and longing the position of stocks that achieved outstanding performance over the past year or the last quarter. Greenward et al. contended that the portfolio window-dress effect could drive up the price of currently successful stocks and depressing stocks with low stock price. So, the end of the reporting period has historically been a good month the value stocks that window-dressing managers have sold. This window-dressing effect, as a matter of facts, seems quite universal. In Hong Kong, when the quarterly or yearly reporting period end date is closely approaching, there will always be news or commentary around featuring its impact on the securities market. On the other hand, scholars from the US suggested window dressing as a possible explanation of the "January Effect" which showed substantial increase in the DJIA in the last week of December. They also thought that this effect is more common for smaller funds as their portfolio are monitored less frequently and completely than that of large funds. Now, this effect is a signal in the securities market that will boost the stock indexes.
In Summary investment institution polices and money manager psychologies facilitate the existence of biases that allow stocks being undervalued persistently even though investors are smart and active.
In the next article, I will talk about another interesting topic about value investing namely how valuation works.
Reference:
Greenwald. B. C. N. & Kiviat. B. (2001). Value Investing: From Graham to Buffett and Beyond. Wiley.
market folly. (2010). The Hedge Fund Herd Mentality, Piggybacking & Crowded Trades. Retrieved from http://www.marketfolly.com/2010/06/hedge-fund-herd-mentality-piggybacking.html
Fong. K., Gallagher. D. R., Gardner. P. & Swan. P. L. A. (2004). Closer Examination of Investment Manager Herding Behavior. Retrieved from http://wwwdocs.fce.unsw.edu.au/banking/staff/profiles/dgallagher/HerdingBehaviour.pdf
Koch. A. (2012). Herd Behavior and Mutual Fund Performance. Retrieved from http://www.business.pitt.edu/faculty/papers/koch1.pdf
Lakonishok. J., Shleifer. A., Thaler. R. & Vishny. R. (1991). Window Dressing By Pension Fund Managers. Retrieved from http://www.knopers.net/webspace/bjorn/artikelenvalueinvestingdeel2/lakonishok2.pdf
