Practical analysis for investment professionals
14 April 2014

How Technology Can Help You Commit Fewer Investment Mistakes

It may seem as if the admonitions and lessons of behavioral finance are difficult to recognize, let alone correct. But as Clare Flynn Levy, founder and CEO of Essentia Analytics, has learned, technology can help you avoid many of the investment mistakes that result from behavioral biases.

While the idea is simple, the implications are far-reaching: The firm’s software analyzes historical trade data and identifies behavioral patterns that show managers where their skills lie and where they’re getting in their own way. Then, armed with data, managers are better equipped to do something about their own decision-making processes.

In so doing, Essentia Analytics tries to solve a common fund management problem: selling skill, but getting paid for performance; where performance is an outcome and not a measure of skill. So how do you measure skill?

Before founding Essentia Analytics, Levy spent more than a decade managing active equity and hedge strategies for various firms. Here she discusses how she believes her firm’s products can help you become a better research analyst and fund manager.

CFA Institute: We all trust the science discovered and discussed by behavioral economics. Namely, we frequently make mistakes based on emotions. Yet, aren’t the conclusions of behavioral economics a little depressing? Essentially they have masterfully identified a disease — too much emotion and unconsciousness in decisions — but then said, “There is nothing you can do about the disease.” What do you think?

Clare Flynn Levy: That’s definitely one way of looking at it, although to me, the diagnosis of the “disease” presents an opportunity. In my view, investment skill is a function of both the conscious decisions we make and the unconscious decisions we make. To maximize skill, therefore, a fund manager can start by maximizing the return to conscious decisions, through honing a deliberate process and being disciplined about implementing it. Unconscious decisions fall into two camps: the unconscious bias upon which behavioral finance focuses, and intuition, which I see as the flip side of the same coin.

While I accept that there’s nothing you can do about feeling the emotions that underlie unconscious bias, that doesn’t mean you have to act on them. Minimizing the negative return to unconscious bias is about identifying it when it arises (or when it is likely to arise), and putting measures in place to mitigate not acting on it. In the case of confirmation bias, for example, that might mean running an investment thesis past someone you know has an opposing view, and making that a deliberate step in your investment process. Meanwhile, it’s in a fund manager’s interest to maximize the return to intuition. That means recognizing what it feels like, and how it differs from unconscious bias, then incorporating steps into the investment process that capitalize on it.

How does your company, Essentia Analytics, help investment pros cope with some of the issues you just described?

Essentia’s software effectively provides fund managers with an electronic feedback loop. It starts with analyzing historical trade data and identifying behavioral patterns. Some people are very skilled at picking stocks, but end up destroying value through timing decisions. Others behave very differently when they are making money compared with when they are losing money, exacerbating losses and limiting gains. Once you can see data that shows you where your skills actually lie and where you’re getting in your own way, you’re in a position to do something about it. And once our clients have a clearer picture of what they’ve been doing and how they’ve been adding and destroying value, we make it possible for them to start keeping track of data about the context in which they are making their investment decisions, as well as the intent behind them — the “why” — and to create alerts and checklists to help keep them on the straight and narrow.

What inspired you to create Essentia Analytics and its tools?

I was a fund manager myself — first long-only, then hedge — and I know how difficult it is to tune out the “noise” when you are constantly being inundated with new information. Worse yet, when you are being judged solely on performance, as most fund managers are, luck and skill are often confused. You’re always looking forward and never backward. That lack of learning from the past makes it very difficult to continuously improve. I attempted to keep investment journals numerous times, even via Excel, but the workflow was too laborious and the bandwidth required to get actionable insights out of that data was significant. I founded Essentia to give fund managers what I wish I had had when I was running money  — the ability to do more of what they are good at and less of what they’re not.

What is one thing you can recommend that investors may do to increase their ability to make conscious decisions?

Maximizing the returns to conscious decisions is about process and discipline. It starts with recording an investment thesis and holding any given idea up to a set of key criteria and a structured validation process. It involves entering a position very deliberately, having thought through and documented the key factors that would warrant a change of view. A system like Essentia makes it easy to commit to all of that “in writing” and revisit it later – before you act on impulse or unconscious bias. The beauty of doing that digitally, instead of on paper, is that every step of the way, you are recording data that you can later review to see how effective your process is.


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: ©iStockphoto.com/MaryLB

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About the Author(s)
Jason Voss, CFA

Jason Voss, CFA, tirelessly focuses on improving the ability of investors to better serve end clients. He is the author of the Foreword Reviews Business Book of the Year Finalist, The Intuitive Investor. Previously, Jason was a portfolio manager at Davis Selected Advisers, L.P., where he co-managed the Davis Appreciation and Income Fund to noteworthy returns. He holds a BA in economics and an MBA in finance and accounting from the University of Colorado.

Ethics Statement

My statement of ethics is very simple, really: I treat others as I would like to be treated. In my opinion, all systems of ethics distill to this simple statement. If you believe I have deviated from this standard, I would love to hear from you: jason@jasonapollovoss.com

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