Investment Management: Team vs Individual Approach
Investment decisions are often made collectively by teams rather than individuals. This trend is evident in the 2021 statistic that 64% of all US active mutual funds were managed by teams, as reported by Karagiannidis and Booth in 2022. The primary reason for this team management approach is the belief that collective decision making, where each individual brings unique skills and experiences to the table, can lead to more effective outcomes.
Another motivation for team investment management is to reduce the risk associated with relying on a single key person. While teams can help to counteract certain individual behavioral biases, such as overconfidence in forecasting, they can also introduce new biases or intensify existing ones.
Performance of Team-Managed vs Individual-Managed Mutual Funds
Research on the performance of team-managed versus individual-managed mutual funds has yielded mixed results. Some studies have found that team-managed funds underperform those managed by individuals.
On the other hand, other studies, such as those by Patel and Sarkissian in 2017 and Karagiannidis in 2010, have found the opposite to be true. Furthermore, some studies, such as those by Bliss, Potter, and Schwarz in 2008; Wang in 2016; and Sargis and Chang in 2017, have found no significant difference in performance between team-managed and individual-managed funds.
These mixed findings suggest that there is no inherent advantage to team management, and therefore, managers should focus on establishing an effective structure and culture within their teams.
Three common behavioral biases
Three common behavioral biases that can adversely affect investment teams’ performance are groupthink, authority bias, and aversion to complexity.
Groupthink
Groupthink is a behavioral bias where a team values harmony and consensus over individual viewpoints, leading to a single-minded approach. For instance, a team of portfolio managers might unanimously decide to invest in a popular tech company, ignoring potential risks or alternative investment opportunities.
Authority Bias
Authority bias occurs when team members overly rely on the opinion of an expert or authority figure. For example, a portfolio management team might overly depend on the insights of a senior analyst, disregarding the input of other team members.
Aversion to Complexity
Aversion to complexity, also known as “bike-shedding,” is a bias where trivial issues receive more attention than complex ones. In portfolio management, this could mean spending more time on familiar investments like blue-chip stocks, while neglecting potentially profitable but complex investments like cryptocurrency.
Investment Team Meetings and Decision-Making Process
Investment team meetings play a pivotal role in the decision-making process within investment firms. For instance, a study involving over 120 investment committees, such as those at Goldman Sachs or J.P. Morgan, revealed that these committees often spend a significant amount of time on issues they consider unimportant, neglecting more critical and challenging issues such as asset allocation, capital market expectations, and manager selection.
Investment Due Diligence
Investment due diligence should not only inquire about a manager’s personnel but also about the structures and processes the manager has put in place to mitigate behavioral biases. This inquiry could include questions about the size of the investment decision-making team, the decision-making process, the conduct of meetings, and the diversity of the investment team.
Optimal Team Size and Decision-Making Process
Research suggests that an optimal team size is between three and five members. Larger teams can introduce coordination issues and increase the likelihood of groupthink. The decision-making process is also crucial. Using a secret ballot may be preferable to open deliberation as it can reduce groupthink and authority bias.
Meeting Conduct and Agenda
To avoid complexity aversion and availability bias, meeting agendas should be agreed upon in advance, with the most important topics covered first and given the most discussion time.
Team Diversity
Team diversity, in terms of social and cognitive categories, can reduce groupthink and errors. Members of diverse teams may devote more effort to tasks as they are less concerned with socially “fitting in” and avoiding conflict, which is common in homogeneous groups. For these reasons, the CFA Institute has long advocated for diversity, equity, and inclusion.
Practice Questions
Question 1: In the field of investment management, team-based decision making is often preferred over individual decision making. What could be a potential reason for the preference of team management in investment decisions?
- Team management inherently leads to better fund performance.
- Team management reduces the risk associated with relying on a single key person.
- Team management always counteracts individual behavioral biases.
Answer: Choice B is correct.
One of the main reasons for the preference of team management in investment decisions is that it reduces the risk associated with relying on a single key person. In the realm of investment management, the risk associated with relying on a single key person can be significant. If that person leaves the firm or is otherwise unable to perform their duties, it could have a major impact on the performance of the fund. By contrast, a team-based approach spreads the responsibility among several individuals, each of whom can step in if one team member is unable to perform their duties. This can provide a level of redundancy and resilience that is not present in a single-manager approach. Furthermore, a team-based approach can also facilitate a more diverse range of perspectives and ideas, which can potentially lead to better decision-making.
Choice A is incorrect. While it might seem intuitive that team management would inherently lead to better fund performance, research on the performance of team-managed versus individual-managed mutual funds has yielded mixed results. Some studies have found that team-managed funds outperform individual-managed funds, while others have found no significant difference in performance. Therefore, it cannot be definitively stated that team management inherently leads to better fund performance.
Choice C is incorrect. While team management can potentially help to counteract individual behavioral biases, it does not always do so. Behavioral biases, such as overconfidence or anchoring, can still influence team decisions, particularly if the team lacks diversity or if certain team members have a dominant influence. Therefore, while team management can potentially help to mitigate some of the risks associated with individual decision-making, it is not a panacea for all behavioral biases.
Question 2: Various studies have been conducted to compare the performance of team-managed and individual-managed mutual funds. Some studies have found that team-managed funds underperform those managed by individuals, while others have found the opposite. Some studies have even found no significant difference in performance between the two. Given these mixed findings, what should be the focus of managers in a team-managed fund?
- Managers should focus on proving that team management is superior to individual management.
- Managers should focus on establishing an effective structure and culture within their teams.
- Managers should focus on eliminating all individual behavioral biases.
Answer: Choice B is correct.
Given the mixed findings from various studies comparing the performance of team-managed and individual-managed mutual funds, the focus of managers in a team-managed fund should be on establishing an effective structure and culture within their teams. This is because the performance of a team-managed fund is largely dependent on the effectiveness of the team’s structure and culture. A well-structured team with a positive culture can facilitate better decision-making, enhance creativity and innovation, and improve the overall performance of the fund. It can also help to mitigate the potential negative effects of individual behavioral biases, which can adversely affect investment decisions. Therefore, rather than trying to prove that team management is superior to individual management or attempting to eliminate all individual behavioral biases, which is practically impossible, managers should focus on creating an environment that fosters collaboration, communication, and mutual respect among team members.
Choice A is incorrect. Trying to prove that team management is superior to individual management is not the best focus for managers in a team-managed fund. This is because the performance of a fund is influenced by a variety of factors, including the skills and expertise of the managers, the investment strategy of the fund, and the market conditions, among others. Therefore, the superiority of team management over individual management cannot be definitively established.
Choice C is incorrect. While it is important for managers to be aware of and try to mitigate the potential negative effects of individual behavioral biases, it is not realistic or practical to focus on eliminating all individual behavioral biases. Behavioral biases are inherent in human decision-making and cannot be completely eliminated. Instead, managers should focus on creating a team environment that can help to mitigate these biases and enhance the overall decision-making process.
Glossary
- Team Management: A management style that involves a group of people working together to make decisions or complete tasks.
- Individual Management: A management style where one person is responsible for making decisions or completing tasks.
- Aversion to Complexity: A bias where trivial issues receive more attention than complex ones.
- Asset Allocation: The process of dividing investments among different kinds of assets, such as stocks, bonds, real estate, and cash, to optimize the risk/reward tradeoff based on an individual’s or institution’s specific situation and goals.
- Capital Market Expectations: The future expectations of the performance of the capital market.
- Manager Selection: The process of choosing a manager for an investment fund or portfolio.
- Groupthink: A psychological phenomenon that occurs within a group of people in which the desire for harmony or conformity in the group results in an irrational or dysfunctional decision-making outcome.
- Authority Bias: The tendency to attribute greater accuracy to the opinion of an authority figure and be more influenced by that opinion.
LOS 2(f): discuss how behavioral factors affect investment team decision making, and recommend techniques for mitigating their effects