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Akash Miriyala

Wednesday, March 23, 2016

Behavioral Finance at JPMorgan
Behavioral finance is based upon the belief that irrational investor behavior leads to market
anomalies that can be exploited by using a specific trading strategy. The effects of this
irrationality is seen by analyzing stocks that have certain characteristics that tend to outperform;
they may show themselves in different ways, like cheap stocks over expensive ones, or those
with momentum.
The definitions of behavioral finance may be inconsistent in that they may be built upon different
behavioral biases. Most argue that overconfidence and loss aversion create the greatest effect on
prices, however there are other broader biases like recency or anchoring that may also show up.
Another possible inconsistency is that strategies formed on behavioral biases may also be subject
to these very same biases themselves. It is possible to be overestimating your ability to exploit
anomalies created by someone elses overconfidence.
JP Morgan applied behavioral finance concepts to its business through the Intrepid funds they
created which were sold to retail clients. Each fund may have had a different focus such as
American equities, Growth, Value, etc., however they are all actively managed to continuously
exploit opportunities caused by emotional biases in investors. The funds were constructed by
selecting stocks with good value and news and then using a quantitative model to rank them and
then create a portfolio mix. The portfolios are then controlled for risk, exposures to sectors, and
balance of momentum and value.
The Asset Management unit also provided advisory services to help clients apply these
behavioral finance concepts. A system was developed to help identify the emotions that drive a
clients behavior which would then allow the bank to better serve them. The advisor can then use
this information to tailor his offering to the client by choosing certain language and approaches.
JP Morgan was able to identify what key service points need to be hit on for each type of
emotive sign for a client. This allows the advisor to use client reviews to further dig into their
clients to look for passion points and behavioral biases.
The Intrepid funds are beneficial in that they provide investors a way to exploit new arbitrage
opportunities in the market. Being one of the first banks to use behavioral concepts on a wider
scale provided an advantage in that it is good to be early in the game, as technically even the
exploitation of behavioral biases is phased out with time. For this reason, it is good that JP
Morgan also developed competencies in advisory services. This understanding of biases and
what makes clients tick allows them to continuously factor in new information in their strategies
to stay competitive.
Of course, the cost of portfolio management is significant, as there is much that goes into the
construction process. Analysts must filter stocks based on value and momentum, construct
ranking algorithms, and continuously perfect risk and exposure models. But another cost relates
to the aforementioned, in that exploiting these behavioral biases is possibly temporary and one
must continuously be learning and tweaking as competition increase runs the risk of profits being
eaten up.

Akash Miriyala
JP Morgan measures success of using the Lipper benchmark, and in the years after inception, the
firm had all five behavioral products rank in the top 20% for their respective categories. Looking
ahead, JP Morgan looked to roll out different Intrepid products and to also include different
foreign markets. However, considering the increasing competition in the space, JP Morgan must
consider the risk of the number of opportunities to exploit dwindling.