How One Value Manager Survived the 13-Year Bear Market

NN Investment Partners analyzed and tweaked the behavior of portfolio managers to outperform while other value strategies struggled.

NN Investment Partners is headquartered in The Hague, Netherlands. (Peter Boer/Bloomberg)

NN Investment Partners is headquartered in The Hague, Netherlands.

(Peter Boer/Bloomberg)

If value stocks offer a return premium because of investor behavioral biases, then portfolio managers that use a value approach are likely susceptible to similar traps. That was the thinking when global asset manager NN Investment Partners hired Essentia Analytics, a consultancy that quantitatively analyzes behavioral biases by looking at managers’ historic trade information.

In a case study published with the CFA Society Netherlands, NN portfolio manager Robert Davis outlines how his firm used behavioral analytics to understand its managers’ biases and better understand the firm’s strengths and weaknesses.

“Arguably, behavioral finance is central to value investing where implicitly investors believe the market is ‘wrong’ in core assumptions about a company, causing it to trade below intrinsic value,” wrote Davis, senior portfolio manager on the firm’s European equity team. “This would never happen in an efficient market! But as well as exploiting the behavioral biases of others, value investors are prone to several biases of their own: expectation of mean reversion, overconfidence (the investor is right, the market is wrong), loss aversion, to name a few.”

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According to Clare Flynn Levy, CEO of Essentia Analytics, the consulting firm works with “a lot of value managers who are feeling very beaten up and convinced that their performance is entirely dictated by value being out of fashion.”

“But NN is proof that’s not true,” she added. “It will be the biggest influence, but there’s more to it than that. Even if your stock picks are all in a universe that’s not in fashion, you can do better by looking at things like timing and sizing.”

Many value managers have been tripped up by years-long underperformance of value or growth stocks. According to Davis, there have only been four value and growth cycles since the 1970s. In each case, a turn of the cycle was caused by a huge catalyst that required changes to monetary or fiscal policy and for asset managers to rethink stock valuations.

“The key to all of this — including not hurting portfolio manager egos in the process — is that all of the data is derived quantitatively with very little subjective perspective. If the numbers say aspects of a behavioral bias result in positive or negative alpha, there is little room for argument,” he wrote in the case study.

In NN’s example, Essentia Analytics found that the firm was holding on to both losing stocks and winning stocks for too long. NN was also buying volatile stocks when their price was already going up.

Essentia helped NN’s portfolio managers correct these behavioral biases by sending “nudge” messages to alert portfolio managers about, for example, winning positions that are approaching “alpha decay.”

“There is a life span to every stock in your portfolio,” Levy said. “We have a tendency to get lazy and we don’t notice the cracks forming.”