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How this fund duo battle their behavioural biases

How this fund duo battle their behavioural biases

Most investors fail to analyse their decisions for behavioural biases resulting in repeated, but avoidable capital destruction, argues Bertie Thomson, co-manager of the Brown Advisory Global Leaders fund. 

In a bid to tackle classic behavioural biases, such as overconfidence and loss aversion, the company has employed a third party consultant to help it scrutinise its investment decisions.

‘The idea here is to recognise the huge drawbacks that we have as humans doing this activity,’ Thomson (pictured) said.

‘We use a third party behavioural consultant who analyses all of our trades and at the same time we send anything we are talking about and all discussions to this consultant.’

By also analysing decisions not to invest, Thomson and his co-manager Mike Dillon believe they can target errors of omission and have improved as investors as a result.

‘An example of a company where we had a good process and we didn’t pull the trigger that was highlighted by analysis of our discussions was Intuit, which creates accounting and tax software selling into the US consumer and SME markets,’ said Thomson.

‘It has a high recurring revenue business model and has been very good at migrating people online, with a great customer experience saving people time and money by doing it online. However, we quibbled over the price and with perfect hindsight we should have bought the stock as it continues to do very well.’

The fund has $75 million (£56 million) of assets under management and its strategy seems to be working, delivering annualised returns of 11.3% over the past three years, compared to 7.6% for its Russell Global Large-Cap Net index benchmark.

The fund was launched in 2015 out of Brown Advisory’s London office, after the firm hired Dillon and Thomson from HSBC Global Asset Management and Aberdeen Asset Management, respectively. 

When picking stocks the pair look for multiple durable sources of competitive advantage, including strong brand or intellectual property (IP), economies of scale, and research and development, Thomson said.

‘What we are looking for is a superior customer outcome and usually if a company can deliver this, the customer helps them achieve outstanding economics and by that I mean high return on capital and lots of free cash flow,’ he explained.

Examples of companies that the fund invests in include Microsoft, which the fund managers feel benefits from strong brand and IP, as well as strong R&D and the impact from its growing network of users.

Behavioural bias

The behavioural coach is part of Thomson and Dillon’s effort to improve their investment outcomes beyond traditional stock picking and has helped them develop a number of rules to help mitigate the negative effects of behavioural biases.

‘You cannot control the equity markets, the only thing you can control is your investment process and you need to continually refine that process,’ Thomson says.

‘One of the obvious rules is the loss aversion rule. Loss aversion is the most damaging human behaviour in investing. When you have a loser you don’t want to face up to the loser, because you are facing up to pain and when you sell you will be crystallising the pain in your mind forever.’

The loss aversion rule is that when a stock falls 20% below where the fund bought it or falls 20% relative to its index, an automatic review process is triggered. The team will then go back through the investment thesis and at the end of that analysis the fund either buys more or sells the stock.

‘Typically, when we have done these reviews the outcome has been that they have added value. It really drives into our ethos of self-improvement and we think that humbleness is an underrated attribute and self-confidence is incredibly dangerous in this industry,’ Thomson said.

Capital allocation

The fund also puts a lot of focus on the capital allocation part of its investment process as it seeks to improve its outcomes.

‘The investment process isn’t purely about stock selection, but 95% of the investment community is focused on stock selection and we feel this has left the other part of the investment process, capital allocation, a hugely neglected area and something that sets us apart,’ he said.

‘The idea is to have the most amount of NAV behind the best ideas that can generate the greatest amount of risk-adjusted returns.’

He said they base decisions on capital allocation on not just how large the payout will be, but also the probability of achieving it. This is based on factors such as the quality of a business’s franchise and business model.

‘It means that we don’t just put our capital into the companies with the most pay-off, but rather the companies with the best chance of achieving their potential. Most investors look at the payout when in reality the probability of that payout being realised is incredibly important, because if you only looked at the payout you could potentially be taking on a lot of risk.’ 

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Mick Dillon
Mick Dillon
60/484 in Equity - Global (Performance over 3 years) Average Total Return: 57.33%
Bertie Thomson
Bertie Thomson
59/484 in Equity - Global (Performance over 3 years) Average Total Return: 57.33%
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