Phantoms in the brain: Stability (certainty) of Investor/manager behavior in uncertain times

Individual investor behavior is unusually predictable, stable and certain despite the environment being fraught with risk and uncertainty. So is the manager’s behavior in firms. All incentives are directed to make such traits of behavior universal.

Constant change or sparks of creativity is not the way that is going to be easily rewarded as it involves trials and tribulations that no firm would be easily ready to accept. Conformism as a trait in human behavior is therefore highly regarded, creativity becomes a secondary pursuit.

Investor and manager behavior that anchored them around the certainty of success around a strategy that proved to be doing good in the past, have been incentivized. Slightest of change in behavior that sometimes did not produce the desired result was penalized and so experimentation is not in the normal DNA of investors or managers.

Also investors want to be in-charge and they must make definitive judgments, no matter how probabilistic the underlying data may be. Their experience with success and failures gives them the air of rigid authority around decisions related with investments. That is the reason you have people who remain long and people who remain speculative in their stances although the reality would point to just the opposite behavior as a rational choice in the given situation; of the millions of investors there would be a few handful who would be the outliers making nimble calls after careful examination of the underlying conditions dispassionately. The market as a whole is a conglomeration of outrageously different positions, but each holding it opposite the other with a rationale you can hardly question. 

But changing a position is not the craft that investors are skillful at, or for that matter managers as well.

The real reason is to be found in the literatures of the behavioral scientists and more recently in the works of scientists of the brain or the neuropsychologists.   

Prospect Theory proved that investors are risk averse when it comes to making losses while they are risk prone when there are higher chances of gains. This asymmetry is the key reason why changing a position is so very difficult as the behavior around a change of position cannot be so easily accepted as the mind closes around an imaginary loss proposition which has a higher weightage than a gain.

Uncertainty around a change is therefore rejected as a loss-making proposition and status quo is easily explained as a better pay-off.  The bias around positions is very forcefully entrenched in the brains.

Great businesses making handsome profits are saddled with this investor or manager behavior where no new direction is accepted as a natural step as past experience with a given direction points to the continuation of success. Some extreme examples are Kodak, Sears, Blockbuster, Motorola or Yahoo. They celebrated their orthodoxy around business models and their single minded pursuit of a line of business direction.

Dow Jones Index of today has only one company that was in the original list, GE, although it had to exit once.

The Bombay Stock exchange currently does not have a single company that was in the original A-list.

This is the best proof of investor and manager behavior that anchored them around the certainty of success around a strategy that proved to be doing well in the past.

The fascinating book, “Phantoms in the brain”, by Ramachandran, gives us some clues as to why our brains are attuned to this predicament of being change-averse.

The right brain is the creative part and it is non-sequential, non-verbal, willing to experiment and make a subjective judgment. It may not know the answer but would find a way to get to it using non-conventional means or trial and error.

The left brain on the other hand is sequential in processing information, is analytical and feverishly objective. It may not be willing to experiment, but will be very good at finding a logical explanation.

Human beings use both the brains, some of them are equally good at both and they make great musicians.

The behavior of investors are guided by the incentives they have seen working well and that posits them to adopt to left brain activity more than the right brain. Finding a logical answer takes precedence over experimenting with an unknown and testing a failure. The incentives also do not make great allowance for such behavior.

Making a comparative progress is what drives the investors to the herd behavior and managers towards peer comparison. It is about following signals, picking up from trends and making inadequate adjustments to the already stable flow of activities that have given reasonably good results.

The choice for making a change in direction, the work of the right brain, is like the child’s behavior in the class room where a non-pertinent question is asked or an alternate method to solve a math problem leaves no time for the other questions in the paper.

Social acceptance of such behavior is still low, conformist, rigid acceptance of the continuing tide of activity fills up our social and mental space.

When you see people reveling in doing the same things and following the same presentations or making the same statements, you know now, what all that is coming from, the left brain. When you see a set of people doing new things, trying and failing and making constant changes in their work flow, there is right brain at play.

Leadership is about making them to work as the brain does, assimilating information from both the sides of the brain and conscientiously making an effort to tie things together. This can hardly be prescribed in a manner which is structured and documented as an SOP.

That is where ‘doing the right things’ as in leadership gets differentiated from ‘doing things right’ as in management. That is also the reason why leadership is rare, while investors and managers abound.