Irrational investors play key role in market inefficiencies: Tyndall

Irrational investor behaviour plays a key role in forming market inefficiencies, according to Tyndall Investment Management head of retail Craig Hobart.

Writing in the newly released Tyndall white paper on Australian equities, entitled “Greed and Fear: Investor behaviour and its influence on market cycles”, Hobart said the two main causes of inefficient markets are ‘heuristic biases’ and ‘frame dependence’ by investors.

“Heuristic biases are essentially ‘rules of thumb’ gained by investors from previous experiences, thereby creating a natural bias based on a previous experience rather than logic.

“An investor who has lost a lot of money in a single mining stock may never invest in mining stocks again in the belief that their previous experience will be repeated.”

Hobart said that the concept of frame dependence centres on people having “frames of reference” when making investment decisions — particularly when it involves risk or uncertainty.

“Investors often focus on the initial capital outlay as the amount ‘at risk’, rather than the accumulated value over time.

“For example, assume an initial investment of $10,000 that one year later rises in value by $1,000. Investors will tend to regard the amount of money at risk as being the initial $10,000, but really the total ‘at risk’ money is $11,000.

“It is this total amount invested that the investor should be constantly re-evaluating when making investment decisions — whether it is to invest more, redeem or switch to another fund/asset class.”