Behavioural Investing

“Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance”
James Montier, John Wiley & Sons, Ltd, 2007 Reviewed by Bruce Grantier for the Brandes Institute1 In this new book, James Montier summarizes an immense body of research on behavioural investing and adds many new insights of his own. The combination makes this book an indispensable reference on this topic. Hopefully,this review will inspire readers to find for themselves what an important book this is and how it may help make one a better investor. Other leading references in this field are Andrei Schleifer’s Inefficient Markets: An Introduction to Behavioural Finance (Oxford, Oxford University Press, 2000), and Richard Thaler’s (editor) Advances in Behavioral Finance - Volumes I and II (New York: RussellSage Foundation, 1993 and 2005). James Montier is Global Strategist at Société Générale. The contents stem from many articles he wrote as global equity strategist at Dresdner Kleinwort, where he won acclaim as a leading academic and practical authority on applying behavioural finance to investing. He also is a visiting fellow at the University of Durham and a fellow of the Royal Society of Arts. Thebook’s first three sections discuss the origin of common mistakes and their roots in basic biases; the next five sections discuss behavioural phenomena. In this review, I follow the same progression; a review of mistakes and biases, followed by a discussion of a number of the behavioural phenomena which I think are potentially of great interest to Brandes constituents. These include: groupdecision making, fallacies of modern finance, the nature and predictability of bubbles, and an important area of behaviour – happiness – or what motivates people (correctly or otherwise).2 Starting with how the brain works, Montier discusses its two information-processing systems – the reflexive and the reflective. The two thought processes could be exemplified by the personalities of McCoy and Spock of“Star Trek” fame. The brain defaults naturally to the emotional (reflexive) system, as opposed to the objective (reflective) system. Indeed, as Montier points out, reflection requires an exertion of energy. Like the use of a muscle, it is actually tiring. Unfortunately for our decision making, two human qualities tend to complicate matters: 1. The brain is hardwired to like short-term gratification(leading to quick and easy decisions). 2. We tend to dislike social-exclusion behaviour (leading to herd-like decisions).
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Bruce Grantier is a member of the Brandes Institute Advisory Board. A version of this review is slated for publication in the Journal of Investment Management. The author thanks Barry Gillman, Director of the Brandes Institute, for introducing this book to its Board. BothBrandes Investment Partners and the Brandes Institute have hosted James Montier as a speaker at select conferences. The Brandes Institute is a division of Brandes Investment Partners, L.P. 2 Daniel Gilbert is the author of Stumbling on Happiness (2006, Alfred A Knopf). He is Professor of Psychology at Harvard and his work is referred to extensively by Montier. Gilbert’s book Stumbling onHappiness was reviewed by the Brandes Institute and appears at the Brandes Institute website as Stumbling on Value.

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Overall, despite our hopes/beliefs that we are logical decision makers, these innate tendencies often cause less-than-rational decisions. Adding to these complications, our minds are inherently susceptible to many forms of bias – some 22, according to Montier. They fall under fourbasic sources with the most important being self-deception, simplification, emotion, and social interaction. Below, I describe what I believe to be the most important biases under each category: Self-deception  Over optimism: People overestimate their ability. The classic behavioural example is when members of a random group are asked if they are above, below, or average drivers. The results...