Wednesday, August 10, 2005

Change is Good or the Disposition Effect Among Mutual Fund Managers by Anna Scherbina, Li Jin

Previous research has shown that individual investors often hold on to losing stocks for too long. It has largely been assumed that this is because individuals are reluctant to admit their mistakes. Empirically this has been shown by many including Odean 1998.

There is some, although less persuasive evidence that professional money managers are less likely to make this financial error.

Short Version:
Scherbina and Jin examine whether Mutual Fund managers exhibit such reluctance. Their finding? The managers, like the individual investors, hold on to losers too long. Their evidence? When new fund managers take over, they are more apt to sell off the losers and start fresh.

Longer Version:
SSRN-Change is Good or the Disposition Effect Among Mutual Fund Managers by Anna Scherbina, Li Jin:
"We document that mutual fund managers exhibit the disposition bias, or the tendency to hold on too long to poorly performing stocks. This bias arises because of the psychological unwillingness to admit past mistakes. We show that new fund managers, who are emotionally unattached to their predecessors' decisions, sell the momentum losers they have inherited more readily than continuing fund managers."
Some key factoids:
  • The authors only look at those funds where the complete manager team is replaced.
  • The sample is amazing! It goes from 1924 to the present and covers over 30,000 managerial changes.
  • "Consistent with the hypothesis of the disposition effect, in the quarter immediately after the new manager takes over, the median sale of the stocks in the losing decile is -100%, while the median stock sale (averaged over the continuing managers) is only -16.75%."
Their conclusion?
"mutual fund managers, much like individual investors are subject to the disposition bias. In order to document the effect, we go to the root of the bias and show that new managers, who are not likely to be attached to past portfolio decisions, make more rationaltrading choices."
While I think this is sort of what would have been expected, it is a victory for behavioral finance.

And interesting to boot! ;)

Scherbina, Anna and Jin, Li, "Change is Good or the Disposition Effect Among Mutual Fund Managers" (February 25, 2005). EFA 2005 Moscow Meetings Paper.

Mmm, I wonder if the same happens when teams make coaching changes?

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