Human beings face an ongoing internal conflict between the head and the heart, between logical reasoning and emotions. Indeed, medical imaging technology can now show that the rational parts of our brain are often in conflict with the emotional parts of our brain.
Investors, at least human investors, face these same tensions. The impact of emotions, which can lead to unhelpful behavioural biases, can’t simply be cancelled out but investors can look to recognise, understand and regulate their emotions.
There are a range of common behavioural biases which have been fairly well documented but the one we want to focus on here is called ‘confirmation’ bias. This refers to a tendency to search for information that confirms an existing opinion. It’s evident outside the world of investment too, most notably in scientific research.
Why are we singling out this behavioural bias? Simply because it’s becoming increasingly important as technology dominates media and as politics becomes more divisive.
One of the impacts of the advances of technology in media is the growth of the ‘filter bubble’, which can act to protect us from views which are too dissimilar to our own. In addition to the filter that is set by the user, technology acts to bring to the reader the news most ‘suited’ to them. It’s somewhat ironic that the immense power of technology is often reduced to an echo chamber for our own views.
Much of this gives the user the illusion of being informed but, partly through the power of confirmation bias, it is largely false confidence. Arguably, the more inaccurate the story, the more likely it’ll go viral. The rise of fake news is a good example of this, with made-up stories (scandalous but just about believable) rewarded by advertising revenue, rather than the amount of truthful insight they provide.
Of course, social media and the rise of divisive politics are related. It’s easier to hate online but also it’s much easier to carry on believing a lie, rather than accept you were fooled. It’s a populist’s dream, with complex multi-national and multi-lateral arguments distilled to one syllable sound bites: offering apparently simple solutions to complex problems.
In essence, the tendency for a confirmation bias has been exaggerated by the proliferation of social media and the rise of more divisive politics.
So, what can we do as investors? The first step is to recognise how powerful the changes have been in media and politics. We have talked about political risk a number of times over recent months but it isn’t limited to the political event, the risk continues beyond the event.
If “confirmation” is not received through the political event itself, then it can be gleaned later through whether the market is reacting positively or negatively to the political decision and its evolving implications. Looking at the EU referendum, sterling has been the main proxy for judging the impact of the vote to leave.
For most investors who took part in the vote, at least part of their perception of whether sterling will strengthen or weaken now is probably traceable to how they voted. For example, a ‘Bremain’ voter would likely have more sympathy for sterling to weaken, as this would validate or (confirm) their view.
To conclude, biases exist and need to be considered and, where possible, diluted. We emphasise a pragmatic approach to investing, so this is an important area for us, as confirmation bias works directly against being pragmatic and open-minded. We try to achieve this by searching for information from multiple sources, including local sources, ensuring team members receive different research and following a disciplined strategy, which can help to limit behavioural biases more generally.
Fund Manager - Miton Multi Asset Team