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How One Value Manager Survived the 13-Year Bear Market

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This content is from: Portfolio


HOW ONE VALUE MANAGER
SURVIVED THE 13-YEAR BEAR MARKET


NN Investment Partners analyzed and tweaked the behavior of portfolio managers
to outperform while other value strategies struggled.


 * By Julie Segal

February 09, 2021

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NN Investment Partners is headquartered in The Hague, Netherlands. (Peter
Boer/Bloomberg)

If value stocks offer a return premium because of investor behavioral biases,
then portfolio managers that use a value approach are likely susceptible to
similar traps. That was the thinking when global asset manager NN Investment
Partners hired Essentia Analytics, a consultancy that quantitatively analyzes
behavioral biases by looking at managers’ historic trade information.



In a case study published with the CFA Society Netherlands, NN portfolio manager
Robert Davis outlines how his firm used behavioral analytics to understand its
managers’ biases and better understand the firm’s strengths and weaknesses.


“Arguably, behavioral finance is central to value investing where implicitly
investors believe the market is ‘wrong’ in core assumptions about a company,
causing it to trade below intrinsic value,” wrote Davis, senior portfolio
manager on the firm’s European equity team. “This would never happen in an
efficient market! But as well as exploiting the behavioral biases of others,
value investors are prone to several biases of their own: expectation of mean
reversion, overconfidence (the investor is right, the market is wrong), loss
aversion, to name a few.”

[II Deep Dive: Active Equity Managers Actually Do Generate Alpha. Here’s How
They Squander It.]



According to Clare Flynn Levy, CEO of Essentia Analytics, the consulting firm
works with “a lot of value managers who are feeling very beaten up and convinced
that their performance is entirely dictated by value being out of fashion.”

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“But NN is proof that’s not true,” she added. “It will be the biggest influence,
but there’s more to it than that. Even if your stock picks are all in a universe
that’s not in fashion, you can do better by looking at things like timing and
sizing.” 

Many value managers have been tripped up by years-long underperformance of value
or growth stocks. According to Davis, there have only been four value and growth
cycles since the 1970s. In each case, a turn of the cycle was caused by a huge
catalyst that required changes to monetary or fiscal policy and for asset
managers to rethink stock valuations. 

“The key to all of this — including not hurting portfolio manager egos in the
process — is that all of the data is derived quantitatively with very little
subjective perspective. If the numbers say aspects of a behavioral bias result
in positive or negative alpha, there is little room for argument,” he wrote in
the case study.



In NN’s example, Essentia Analytics found that the firm was holding on to both
losing stocks and winning stocks for too long. NN was also buying volatile
stocks when their price was already going up.

Essentia helped NN’s portfolio managers correct these behavioral biases by
sending “nudge” messages to alert portfolio managers about, for example, winning
positions that are approaching “alpha decay.”

“There is a life span to every stock in your portfolio,” Levy said. “We have a
tendency to get lazy and we don’t notice the cracks forming.”


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