Behavioural Finance

Project summary

The aim of this research project was to explore the decision-making of institutional investors, in particular insurers and pension schemes, and the biases that may affect their investment decisions. These included, but were not limited to, emotional, psychological and political biases. The project explored what "rational" or “optimal” behaviour could be expected from an institution in certain economic scenarios, based on its investment objectives and underlying values. It then explored whether there was solid evidence that behavioural factors, such as human psychology, company culture, corporate politics and conflicts of interest caused them to deviate from optimal behaviour. The research provided a number of practical conclusions that can be used by actuaries working in investment and related areas.

Project highlights

ARC Webinar Series 2021 – Understanding biases in trustee decision making

21 January 2021

Professor Peter Ayton, Professor Iain Clacher, Colin Strong and Dr Leonardo Weiss-Cohen presented their research findings in the first of the ARC Webinar Series 2021. Drawing on experimental and qualitative research techniques, along with a literature review of existing psychology and behavioural economics, the research team concluded that trustees were not immune from decision-making biases and proposed ways in which these could be reduced.

The presentation was followed by a panel discussion and Q&A.   A recording of the webinar is available on YouTube and has been posted on the online learning webpages.

Final Report

21 January 2021

The Final Report, entitled Pension Trustee Decision Making, was launched at the ARC Behavioural Finance Webinar on 21 January 2021. The report investigated potential biases that could arise in group decision making and offered a number of recommendations for enhancing decision making by trustees. In its Foreword, the Behavioural Finance Steering Group highlighted the report’s relevance for anyone who is involved in group decision making, acts as an advisor or makes decisions on behalf of others.

The research findings were discussed by Professor Peter Ayton in an article in The Actuary. Split decisions: Pension trustees and decision-making looked at group thinking and decision heuristics and presented the case for improving the collective efficacy of trustee boards.

Media coverage

• Professional Pensions published an article on 21 January on the Report entitled ‘IFoA makes recommendations for improving pension trustee judgement and decision making’.
• Pension Age covered the report in its article ‘IFoA outlines trustee decision making best practice amid evidence of decision biases’.
• The findings were also the subject of a Burges Salmon blog post in Lexology. 

Project background

To date, a substantial volume of work has been undertaken in the field of behavioural finance to explore the psychological factors affecting investment decisions made by individuals.  In contrast, “behavioural” factors (such as politics or human psychology) affecting decisions and actions made by institutional investors, such as insurers or pension schemes, are less understood.  This could be significant for actuaries working in the areas of investment advice, asset-liability matching, liability-driven investments and investment risk management within institutional investors, such as insurance companies and defined benefit pension schemes. A significant number of actuaries work today as advisors to institutional investors’ key decision-making bodies.  Typical roles could include:

• Investment advisors to occupational pension schemes
• Professionals setting the investment strategy for assets of insurance companies
• Investment strategists for assets backing long-term life insurance liabilities, such as with-profit or annuity funds

Investment objectives and asset allocation decisions for the types of organisations mentioned above would typically be expected to be driven by the long term relationship between the value of assets and the actuarial or accounting value of liabilities. In setting a long term investment strategy, investment actuaries are often required to form judgements and make assumptions (explicit or implicit) based on commonly accepted economic theories.  This usually relies on the expectation of rational behaviour, in line with stated public objectives of these organisations and efficient market hypothesis in various forms.

The objective of this research was to test whether the actual decisions made by organisations, as groups of individuals, are influenced by a wider set of factors, such as emotions, human psychology, company culture, corporate politics and conflicts of interest.  This could provide a better tool kit for actuaries and other professionals in managing risks and making financial projections for these organisations.

Research outputs

• Behavioral Biases in Pension Fund Trustees’ Decision Making  was published in the Review of Behavioral Finance in June 2019. This set out the landscape in which pension fund trustees operate and make their decisions. The paper reviewed the literature of behavioural finance research applicable to similar situations to identify avenues of further exploration.
• Extraneous menu-effects influence financial decisions made by pension trustees  was published in Economic Letters in Feb 2020. The research team tested 252 pension scheme trustees for the influence of extraneous manipulations to the menu of options on investment decisions. They found that trustees were influenced by changes to the menu item mix, context and layout. The paper concluded that care should be taken when preparing information presented to trustees, in order to reduce biases that can be detrimental to pension outcomes.
• Pension scheme trustees as surrogate decision makers  was published by Finance Research Letters in April 2021. This found that when setting targets for pension replacement income, trustees project their own preferences instead of reflecting member preferences.
• Professional investors make better mutual fund selections  research report found that pension professionals tend to choose the cheapest mutual fund, regardless of past performance.
• The final report on Pension Trustee Decision Making provided a summary of the research with a number of practical recommendations for actuarial investment practitioners.

IFoA events

• NED event: Behavioural Finance and Boards, 18 June 2019. A recording from this event is available here. 
• ARC Webinar Series 2018: Behavioural Aspects of Institutional Investment Decision-Making, 4 October 2018. Professor Peter Ayton (City, University of London) and co-researcher Dr Iain Clacher (University of Leeds) explore some of the early developments in this research programme. A recording of the webinar is available on YouTube and is also posted on the IFoA's online learning webpages.

Presentations

• Dr Iain Clacher gave a webinar titled: All Too Human: Behavioural Finance Biases in Trustee Decision Making for The Financial Services Club, May 2020. Download a copy of the slides
• Professor Peter Ayton gave a presentation at the Australasian Actuarial Education and Research Symposium, Nov 2019 
• Dr Leo Cohen gave a keynote speech at the Professional Pensions Conference, Nov 2019
• The research team gave a presentation at the IFoA's Investment Strategy for DB and DC Pension Funds seminar, Sept 2019
• Dr Iain Clacher gave a presentation at a PLSA meeting showcasing some of the early findings of this work, June 2019
• Presentation to the Competition and Markets Authority, May 2019
• Invited talk at the FCA seminar series, Jan 2019