Preface xvii Acknowledgments xxi Section I: Common Mistakes and Basic Biases 1 1 Emotion, Neuroscience and Investing: Investors as Dopamine Addicts 3 Spock or McCoy? 5 The Primary of Emotion 5 Emotions: Body or Brain? 6 Emotion: Good, Bad of Both? 7 Self-Control is Like a Muscle 11 Hard-Wired for the Short Term 13 Hard-Wired to Herd 14 Plasticity as Salvation 15 2 Part Man, Part Monkey 17 The Biases We Face 19 Bias #1: I Know Better, Because I Know More 19 The Illusion of Knowledge: More Information Isn't Better Information 20 Professionals Worse than Chance! 21 The Illusion of Control 22 Bias #2: Big ¿ Important 23 Bias #3: Show Me What I Want to See 23 Bias #4: Heads was Skill, Tails was Bad Luck 24 Bias #5: I Knew it all Along 25 Bias #6: The Irrelevant has Value as Input 25 Bias #7: I Can Make a Judgement Based on What it Looks Like 27 Bias #8: That's Not the Way I Remember it 28 Bias #9: If you Tell Me it Is So, It Must be True 29 Bias #10: A Loss Isn't a Loss Until I Take It 30 Conclusions 35 3 Take a Walk on the Wild Side 37 Impact Bias 39 Empathy Gaps 40 Combating the Biases 44 4 Brain Damage, Addicts and Pigeons 47 5 What Do Secretaries' Dustbins and the Da Vinci Code have in Common? 55 6 The Limits to Learning 63 Self-Attribution Bias: Heads is Skill, Tails is Bad Luck 67 Hindsight Bias: I Knew it All Along 69 Skinner's Pigeons 71 Illusion of Control 72 Feedback Distortion 73 Conclusions 76 Section II: The Professionals and the Biases 77 7 Behaving Badly 79 The Test 81 The Results 82 Overoptimism 82 Confirmatory Bias 83 Representativeness 84 The Cognitive Reflection Task (CRT) 85 Anchoring 87 Framing 87 Loss Aversion 89 Keynes's beauty contest 90 Monty Hall Problem 92 Conclusions 94 Section III: The Seven Sins of Fund Management 95 8 A Behavioural Critique 97 Sin city 99 Sin 1: Forecasting (Pride) 99 Sin 2: The Illusion of Knowledge (Gluttony) 100 Sin 3: Meeting Companies (Lust) 100 Sin 4: Thinking You Can Outsmart Everyone Else (Envy) 100 Sin 5: Short Time Horizons and Overtrading (Avarice) 101 Sin 6: Believing Everything You Read (Sloth) 101 Sin 7: Group-Based Decisions (Wrath) 101 Alternative Approaches and Future Directions 102 Sin 1: Forecasting (Pride) 103 9 The Folly of Forecasting: Ignore all Economists, Strategists, & Analysts 105 Overconfidence as a Driver of Poor Forecasting 109 Overconfidence and Experts 110 Why Forecast When the Evidence Shows You Can't? 114 Unskilled and Unaware 115 Ego Defence Mechanism 115 Why Use Forecasts? 119 Debasing 120 10 What Value Analysts? 123 Sin 2: Illusion of Knowledge (Gluttony) 131 11 The Illusion of Knowledge or Is More Information Better Information? 133 Sin 3: Meeting Companies (Lust) 141 12 Why Waste Your Time Listening to Company Management? 143 Managers are Just as Biased as the Rest of Us 145 Confirmatory Bias and Biased Assimilation 148 Obedience to Authority 151 Truth or Lie? 153 Conclusions 157 Sin 4: Thinking You Can Outsmart Everyone Else (Envy) 159 13 Who's a Pretty Boy Then? Or Beauty Contests, Rationality and Greater Fools 161 Background 163 The Game 163 The Solution 164 The Results 165 A Simple Model of Our Contest 168 Comparison with Other Experiments 170 Learning 173 Conclusions 174 Sin 5: Short Time Horizons and Overtrading (Avarice) 177 14 ADHD, Time Horizons and Underperformance 179 Sin 6: Believing Everything You Read (Sloth) 187 15 The Story is The Thing (or The Allure of Growth) 189 16 Scepticism is Rare or (Descartes vs Spinoza) 197 Cartesian Systems 199 Spinozan Systems 199 Libraries 200 A Testing Structure 200 The Empirical Evidence 200 Strategies to Counteract Naïve Belief 203 Sin 7: Group Decisions (Wrath) 207 17 Are Two Heads Better Than One? 209 Beating the Biases 215 Section IV: Investment Process as Behavioural Defence 217 18 The Tao of Investing 219 Part A: the Behavioral Investor 223 19 Come Out of the Closet (or, Show Me the Alpha) 225 The Alpha 228 The Evolution of the Mutual Fund Industry 229 Characteristics of the Funds 231 The Average and Aggregate Active Share 231 Persistence and Performance 231 Conclusions 233 20 Strange Brew 235 The Long Run 237 Death of Indexing 238 Getting the Long Run Right 238 The Short Run 239 Tactical Asset Allocation 239 Equity Managers 240 Break the Long-Only Constraint 242 Add Breadth 244 Not Just an Excuse for Hedge Funds 245 Truly Alternative Investments 245 Conclusions 246 21 Contrarian or Conformist? 247 22 Painting by Numbers: An Ode to Quant 259 Neurosis or Psychosis? 261 Brain Damage Detection 262 University Admissions 263 Criminal Recidivism 263 Bordeaux Wine 263 Purchasing Managers 264 Meta-Analysis 264 The Good News 267 So Why Not Quant? 268 23 The Perfect Value Investor 271 Trait I: High Concentration In Portfolios 273 Trait II: They Don't Need to Know Everything, and Don't Get Caught in the Noise 276 Trait III: A Willingness to Hold Cash 276 Trait IV: Long Time Horizons 277 Trait V: An Acceptance of Bad Years 278 Trait VI: Prepared to Close Funds 278 24 A Blast from the Past 279 The Unheeded Words of Keynes and Graham 281 On the Separation of Speculation and Investment 281 On the Nature of Excess Volatility 282 On the Folly of Forecasting 283 On the Role of Governance and Agency Problems 284 On the Importance (and Pain) of Being a Contrarian 285 On the Flaws of Professional Investors 286 On the Limits to Arbitrage 286 On the Importance of the Long Time Horizon 287 On the Difficulty of Defining Value 288 On the Need to Understand Price Relative to Value 288 On Why Behavioural Errors don't Cancel Out 289 On Diversification 289 On the Current Juncture 289 On the Margin of Safety 290 On Beta 291 On the Dangers of Overcomplicating 291 On the Use of History 291 25 Why Not Value? The Behavioural Stumbling Blocks 293 Knowledge ¿ Behaviour 295 Loss Aversion 296 Delayed Gratification and Hard-Wiring for the Short Term 297 Social Pain and the Herding Habit 300 Poor Stories 301 Overconfidence 301 Fun 303 No, Honestly I Will Be Good 303 Part B: the Empirical Evidence: Value in All Its Forms 305 26 Bargain Hunter (or It Offers Me Protection) 307Written with Rui Antunes The Methodology 308 Does Value Work? 309 The Anatomy of Value 310 The Siren of Growth 311 Growth Doesn't Mean Ignoring Valuation 311 The Disappointing Reality of Growth 313 Analyst Accuracy? 314 Value versus Growth 316 Key points 317 Regional Tables 318 Global 318 USA 320 Europe 323 Japan 325 27 Better Value (or The Dean Was Right!) 329Written with Rui Antunes 28 The Little Note that Beats the Market 337Written with Sebastian Lancetti The Methodology and the Data 339 The Results 340 The Little Book Works 340 Value Works 341 EBIT/EV Better than Simple PE 341 Quality Matters for Value 341 Career Defence as an Investment Strategy 342 What About the Long/Short View? 343 The Future for the Little Book 344 Tables and Figures 345 Regional Results 345 29 Improving Returns Using Inside Information 355 Patience is a Virtue 357 Using Inside Information 357 A Hedge Perspective 359 Risk or Mispricing? 359 Evidence for Behavioural Errors 360 Evidence Against the Risk View 361 European Evidence 363 Conclusions 365 30 Just a Little Patience: Part I 367 31 Just a Little Patience: Part II 375Written with Sebastian Lancetti Value Perspective 377 Growth Perspective 380 Growth and Momentum 381 Value for Growth Investors 382 Value and Momentum 383 Implications 383 32 Sectors, Value and Momentum 387 Value 389 Momentum 389 Sectors: Value or Growth 390 Stocks or Sectors 391 33 Sector-Relative Factors Works Best 395Written with Andrew Lapthorne Methodology 398 The Results 398 Conclusion 403 34 Cheap Countries Outperform 405 Strategy by Strategy Information 409 Part C: Risk, but Not as We Know It 423 35 CAPM is CRAP (or, The Dead Parrot Lives!) 425 A Brief History of Time 427 CAPM in Practice 427 Why Does CAPM Fail? 431 CAPM Today and Implications 432 36 Risk Managers or Risk Maniacs? 437 37 Risk: Finance's Favourite Four-Letter Word 445 The Psychology of Risk 447 Risk in Performance Measurement 447 Risk from an Investment Perspective 448 Section V: Bubbles and Behaviour 453 38 The Anatomy of a Bubble 455 Displacement 457 Credit Creation 457 Euphoria 459 Critical Stage/Financial Distress 459 Revulsion 463 39 De-bubbling: Alpha Generation 469 Bubbles in the Laboratory 471 Bubbles in the Field 472 Displacement: The Birth of a Boom 473 Credit Creation: Nurturing the Boom 473 Euphoria 476 Critical Stage/Financial Distress 477 Revulsion 483 Applications 487 Asset Allocation 487 Alpha Generation 488 Balance Sheets 489 Earnings Quality 489 Capital Expenditure 490 Long-Only Funds 491 Summary 491 40 Running with the Devil: A Cynical Bubble 493 The Main Types of Bubble 496 Rational/Near Rational Bubbles 496 Intrinsic Bubbles 498 Fads 499 Informational Bubbles 499 Psychology of Bubbles 500 Composite Bubbles and the De-Bubbling Process 500 Experimental Evidence: Bubble Echoes 503 Market Dynamics and the Investment Dangers of Near Rational Bubbles 503 Conclusions 505 41 Bubble Echoes: The Empirical Evidence 507 Conclusions 516 Section VI: Investment Myth Busters 519 42 Belief Bias and the Zen Investing 521 Belief Bias and the X-System 524 Confidence Isn't a Proxy for Accuracy 528 Belief Bias and the Zen of Investing 528 43 Dividends Do Matter 529 Conclusions 540 44 Dividends, Repurchases, Earnings and the Coming Slowdown 541 45 Return of the Robber Barons 549 46 The Purgatory of Low Returns 563 47 How Important is the Cycle? 573 48 Have We Really Learnt So Little? 581 49 Some Random Musings on Alternative Assets 587 Hedge Funds 589 Commodities 590 Which Index? 590 Composition of Commodity Futures Returns 591 The Times They are A-Changin' 591 Conclusions 595 Section VII: Corporate Governance and Ethics 597 50 Abu Ghraib: Lesson from Behavioural Finance and for Corporate Governance 599 Fundamental Attribution Error 601 Zimbardo's Prison Experiment 602 Milgram: The Man that Shocked the World 604 Conditions that Turn Good People Bad 608 Conclusions 609 51...