Cute new paper out arguing that some of the stupid human tricks usually ascribed by behavioral finance sorts to self-destructive investor behaviors may not always and everywhere be so dumb. Maybe they’re just mostly dumb.
The recent behavioral literature has shown that individual investors hold concentrated portfolios, trade excessively, and exhibit a preference for local stocks. These results are puzzling because in all three instances portfolio distortions could reflect either an informational advantage or psychological biases. In this study, we propose a demographics-based proxy for smartness and show that the portfolio distortions of "smart" investors reflect an informational advantage that generate high risk-adjusted returns. In contrast, the distortions of "dumb" investors arise from psychological biases because they experience low risk-adjusted performance. When we do not condition on the level of portfolio distortions, the average net performance of smart investors does not beat passive benchmarks, but smart investors outperform dumb investors by about 3 percent annually on a risk-adjusted basis. Further, when portfolio distortions are large, smart investors outperform the passive benchmarks by about 2 percent and the smart-dumb performance differential is over 5 percent. We also show that a portfolio of stocks with smart investor clientele outperforms the dumb clientele portfolio by about 3.50 percent annually. Taken together, these results indicate that both behavioral and information-based explanations for observed portfolio distortions are appropriate, but they apply to groups of dumb and smart investors, respectively.
Source:
George M. Korniotis and Alok Kumar, “Do Portfolio Distortions Reflect Superior Information or Psychological Biases?,” SSRN eLibrary (July 16, 2009), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1018668.
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