Emotional responses are far more likely to drive share investment decisions than any concept of efficient investing, according to Melbourne University investment manager Geoff Ballard.
Speaking at a Securities Institute briefing yesterday Ballard said modern finance theory ignores basic emotional factors and responses to market conditions.
“Investment markets are not efficient and should be assumed to be so until proven otherwise,” Ballard says.
“Far from being a rational process, the decision to buy or sell is often an emotive one. This is particularly so when the market experiences extreme volatility.”
The efficient market concept assumes investor’s decisions are based on rational choices according to Ballard, and these investors are sophisticated in their understanding of the market.
“The efficient market idea does away with the behavioural aspects such as greed and fear and other emotional baggage. However financial and economic history support the findings of behavioural studies and that is people are not always rational,” Ballard says.
Ballard says there are a number of behavioural traits which are evident in the investment industry which emphasis the inefficiency of markets.
“In areas such as index tracking, many fund managers are keen to track a chosen index so they do not deviate from the index performance. This can lead to inefficient short term horizons,” Ballard says.
“Usually the motive is to keep any existing funds and use the performance results as a marketing tool, assuming that any tracking is in fact positive.”
He also says there is a tendency for investors and investment professionals to develop a herd mentality which leads to consensus views, even when these are wrong.
At the same time, Ballard says it is also worth remembering that financial markets behave the same way as crowds do even though the crowd is not in one physical space.
“Without recognising crowd logic or crowd madness, theories of finance are incomplete. The focus should be on the irrationality of the crowd which is evidenced by the development of manic behaviour in investments and the usual aftermath of the panic responses.”
