Behavioral Finance At Jpmorgan - Report

Akash Miriyala Wednesday, March 23, 2016 F419 Behavioral Finance at JPMorgan Behavioral finance is based upon the belief that irrational investor behavior leads to market anomalies that can be exploited by using a specific trading strategy. The effects of this irrationality is seen by analyzing stocks that have certain characteristics that tend to outperform; they may show themselves in different ways, like cheap stocks over expensive ones, or those with momentum. The definitions of behavioral finance may be inconsistent in that they may be built upon different behavioral biases. Most argue that overconfidence and loss aversion create the greatest effect on prices, however there are other broader biases like recency or anchoring that may also show up. Another possible inconsistency is that strategies formed on behavioral biases may also be subject to these very same biases themselves. It is possible to be overestimating your ability to exploit anomalies created by someone else’s overconfidence. JP Morgan applied behavioral finance concepts to its business through the Intrepid funds they created which were sold to retail clients. Each fund may have had a different focus such as American equities, Growth, Value, etc., however they are all actively managed to continuously exploit opportunities caused by emotional biases in investors. The funds were constructed by selecting stocks with good value and news and then using a quantitative model to rank them and then create a portfolio mix. The portfolios are then controlled for risk, exposures to sectors, and balance of momentum and value. The Asset Management unit also provided advisory services to help clients apply these behavioral finance concepts. A system was developed to help identify the emotions that drive a client’s behavior which would then allow the bank to better serve them. The advisor can then use this information to tailor his offering to the client by choosing certain language and approaches. JP Morgan was able to identify what key service points need to be hit on for each type of emotive sign for a client. This allows the advisor to use client reviews to further dig into their clients to look for passion points and behavioral biases. The Intrepid funds are beneficial in that they provide investors a way to exploit new arbitrage opportunities in the market. Being one of the first banks to use behavioral concepts on a wider scale provided an advantage in that it is good to be early in the game, as technically even the exploitation of behavioral biases is phased out with time. For this reason, it is good that JP Morgan also developed competencies in advisory services. This understanding of biases and what makes clients tick allows them to continuously factor in new information in their strategies to stay competitive. Of course, the cost of portfolio management is significant, as there is much that goes into the construction process. Analysts must filter stocks based on value and momentum, construct ranking algorithms, and continuously perfect risk and exposure models. But another cost relates to the aforementioned, in that exploiting these behavioral biases is possibly temporary and one must continuously be learning and tweaking as competition increase runs the risk of profits being eaten up.

Akash Miriyala F419 JP Morgan measures success of using the Lipper benchmark, and in the years after inception, the firm had all five behavioral products rank in the top 20% for their respective categories. Looking ahead, JP Morgan looked to roll out different Intrepid products and to also include different foreign markets. However, considering the increasing competition in the space, JP Morgan must consider the risk of the number of opportunities to exploit dwindling.