Cognitive biases are less pronounced among managers of large investment funds. But this is only about some such biases, and this still does not mean that big money automatically makes a person a more rational subject. This conclusion is reached by researchers Richard Harris from the University of Bristol and Murat Mazibash from the University of Dundee in a new joint study. The reason for this limited effect may not lie in the managers’ special psychological resilience, nor even in their accumulated experience. Why does this happen, and what lessons can private investors draw from it?

How the study was conducted

For their work, the authors examined nearly 187 thousand funds across different asset classes, investment styles, and regions. The sample included data from 1990–2022 on funds with assets under management exceeding $100 billion. Based on the distribution of returns, researchers assessed behavioral parameters related to how people perceive gains, losses, and event probabilities. In this part, the scholars relied on prospect theory: people do not evaluate a financial outcome by itself, but relative to some reference point.

For one investor, a loss is a decrease in an asset’s value from the price they bought it at; for another, it’s a deviation from the index’s return; for a third, it’s the missed profit they expected. The specific reference point—what we end up “dancing to”—ultimately affects the decision.

At the same time, the researchers did not directly observe managers’ trades and did not see portfolio compositions; they worked only with data on fund returns. Therefore, the study is really about reconstructing a behavioral profile.

What the results showed

On average, managers from the Harris and Mazibash sample demonstrated typical patterns described in behavioral economics: loss aversion, reduced sensitivity to further changes in outcomes, and distorted probabilities of events. Moreover, in the model used, a loss of a given size on average affects the manager’s subjective evaluation of the financial outcome more than a profit of the same size. In the authors’ interpretation, this means that on average managers show a lower propensity for risk in loss situations.

The largest funds were also less tempted by very unlikely gains: they were less likely to follow a scenario that could produce very high profits but with a small probability. For smaller funds, this tendency was stronger. The authors attribute this to the fact that large funds can afford a more diversified strategy and depend less on a single risky trade.

Researchers take their reasoning further: in their view, there’s no reason to assume that managers of the largest funds understand the market better. Perhaps they have decision-making tools that prevent emotions from taking the upper hand. This could be a separate group of analysts who validate one idea or another, pre-approved limits that prevent an excessively growing losing position, an investment committee with all the required procedures, and so on. In such a system, rationality is embedded into the structure and process rather than being left to the discretion of one or two leaders.

That said, even a large system with well-tuned procedures cannot fully guarantee a rational approach. The authors emphasize: the system should create conditions in which a rational decision is easier to make and harder to violate. That is, the system is not aimed at eliminating cognitive biases, but at controlling them.

Experience is not the same as training

Another research finding seems less logical: the tenure/experience of a fund manager turned out to be far less important than the fund’s size. Differences between groups of managers with varying experience were statistically significant, but small. At the same time, the spread between individual managers within groups by fund size was noticeable. That is, the average tenure group differed from the managers with the most modest experience on a number of parameters, but this dependency was not linear: the most experienced do not always occupy the extreme positions.

In other words, tenure only indicates how much time a person spent in the market. By itself, it tells nothing about how a person evaluates their own decisions and how effective they are.

We usually think that professional experience means being able to recognize mistakes, maneuver through market fluctuations, and cope with psychological pressure at least within oneself. But as the research data suggests, it can also mean that a manager for years simply follows the same habit—sometimes not the right one for the fund.

For example, they may look for confirmation of a decision they’ve already made, perceive prior success as proof that their approach is correct, avoid actions that might force them to admit their own mistake, or rely on personal intuition where external oversight is needed. In essence, these are the same cognitive biases, just operating differently compared with those that a large-fund system learned how to manage.

How to build protection against yourself

The study shows that among the largest funds, some cognitive biases that manifest in managers’ behavior are, on average, expressed more weakly. This means that the size may be related to a more resilient way of making decisions. In other words, you need processes that make emotional influence on the manager even more noticeable and more restrained before it gradually starts to affect actions imperceptibly.

For this, you should first visualize in the greatest possible detail the process of executing a deal: set exit conditions in advance, provide arguments against entering into the agreement, and separate the quality of the process from the financial outcome. In other words, if a fund evaluates only the result, this can lead to building a risky habit and a factor of sheer luck into the rule.

In the end, the infrastructure within the fund itself — the team of analysts, risk control, diversification, procedures, and the ability to withstand temporary setbacks — may be just as important as the manager directly.

For the private investor, the lesson is that it’s not so much the trades themselves that matter, but the organization of trading processes in the stock market.ㅤ

#WorldIsFullOfInterestingStories

You can also stay without the news—those who forget to subscribe… 🤔