Good Investment Advice – Don’t Watch the Keeper

Lyle Stein - June 19, 2014

With the opening matches of the 2014 World Cup underway, the world is once again focused on “the beautiful game.” Following the tournament’s Group stage, 16 finalists enter the knockout round where each game must have a winner. If a game is tied after 90 minutes of regulation play and 30 minutes of added time, the match will be determined by a series of penalty kicks: a shooter-on-goalkeeper matchup that is thick with tension. In a penalty kick, the shooter is expected to score, since the keeper has little chance of covering the nearly 200 square foot goal. Facing such a daunting task, goalkeeper tendency is to dive either left or right, in the rare hope of stopping the shot. With correct anticipation, the goalie has a chance of becoming a national hero by making a “brilliant” save.

About 10 years ago, psychologists studied the behaviour of goalkeepers during penalty kicks. Specifically, they analyzed whether the left/right diving behaviour of the goalie was actually more productive than simply standing in the middle of the goal.1 In a study of 286 penalty kicks at high-level games, they discovered that if the goalie simply stood still in the middle of the net, a better outcome (saves) would result.

Why is this of interest to investors?

Humans have a natural tendency to act. Studies show that an adverse outcome resulting from a situation where action is taken is perceived more positively than an adverse outcome where no action is taken. This action bias is exactly what the authors examined in their penalty kick study.

Professional investors, like professional goalies, work in high-performance occupations. Bombarded with constant information (some useful, some not), investors make decisions that are often right, but frequently not. While not viewed on world television like a World Cup goalie, the portfolio results of investment decisions are readily seen and easily scrutinized. An active manager is easily perceived as having a good handle on all the financial and economic information processed.

This is where psychology comes in. It is human nature to equate action with success. The fact that a goalie did something (moved right or left) in a difficult situation is actually perceived by the observer as a favourable action compared to doing nothing, which in reality offers the best chance of a positive outcome. A portfolio manager who is seen as actively trading a portfolio is often viewed more favourably – because they are doing something – than a manager who maintains more of a buy-and-hold approach, even though each transaction incurs a real cost to the portfolio. Likewise, it is interesting that the traditional brokerage model, where commissions are generated via trading activity, rewards broker action, and not necessarily investment results.

Who is the better goalie, the one who moves or the one who stands still? Only time will tell. Over the short-term, (a single World Cup), no one would fault the goalkeeper for moving. The same is true for the investment manager. Like a goalkeeper, a trader is constantly changing positions in response to changing market information. In the near-term, the activity appears beneficial, and underperformance (like a dive to the right) can be overlooked. In the long run, however, excessive trading imposes a real economic cost to an investment portfolio. Not only are costs incurred in transacting (commissions, the bid-ask spread), but opportunity costs such as dividends may be foregone as well. The problem is that the appropriate time frame for a proper assessment (a four week World Cup, a 5 year market cycle) may be too short to accurately measure.

At Leon Frazer, we have learned over the years that the best position is most often in the middle of the goal. Like the authors, we do not believe actions (transactions) equate to competence. Only after careful analysis, like the goalkeeper who has studied the penalty kicker’s tendencies, will we act. Our risk averse nature forces us to carefully weigh the potential benefits of a transaction with the opportunity cost of standing still. Since we are not compensated to dive, we make decisions we believe are in the best interest of our clients. We will miss from time to time, but the benefit of playing the percentages year after year is what our multi-generational clients truly understand.

Action Bias Among Elite Soccer Goalkeepers: The Case of Penalty Kicks;” M. Bar-Eli, O. Azar, I. Ritov, Y. Keidar-Levin and G. Schein, MPRA, 2005.

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