On my desk is a paper that purports to show how investment preferences are correlated with personality. The paper doesn't explain that rock-climbers like stocks, while librarians favour bonds. Arguments that physical risk-takers prefer equities have come and gone (and have largely been discredited). This effort, instead, involves investment styles, and it bears a title that only a professor could love: "Personality Traits and Portfolio Tilts Toward Value and Size."
All right, two professors--the authors being the duo of Andrew Conlin and Jouko Miettunen, from Finland's University of Oulu. (A cold place that; the average January high is -8 degrees Celsius, which doesn't sound a whole lot better when expressed in Fahrenheit.)
Finland, it turns out, takes a rather different view of privacy than does the United States. The authors not only were able to determine "the number of stocks held, the number of shares owned of each stock, and the value of each position" for each person in their study, by viewing the records of the Finnish Central Securities Depository, but they were also able to access those investors' psychological-testing records, which are contained in the Northern Finland Birth Cohort 1966 data set. For investment researchers, at least, Finland is heaven on this earth.
The TCI
The psychological profile gives the results from a test called the Temperament and Character Inventory, or TCI, which, the authors state, "has been used extensively in the fields of medicine and psychiatry." The TCI test measures four personality traits, from which the authors select two: novelty-seeking and reward-dependence.
1. Novelty-Seeking
"Novelty-seeking measures the degree to which one exhibits active behavior in response to stimuli and actively seeks pleasure and reward when none is currently on offer."
Restated into plainer English, people who score highly on novelty-seeking are easily bored. In contrast, those with patience receive low scores.
2. Reward-Dependence
"Reward-dependence measures the degree to which one is emotional and responsive to social stimuli."
People who score highly on reward-dependence care greatly about what others think. Their actions are guided by the social cues that they receive. Conversely, those with low scores are indifferent to public reactions. Frankly, they couldn't give a damn.
The authors then tinker with the subscores for the two traits to measure related traits. Their conclusions:
1. Extravagant people favour large-cap growth stocks.
2. Impulsive people favour small-cap growth stocks.
3. Sentimental people favour small-cap value stocks.
4. Social people favour small-cap stocks, period (with a modest value tilt).
In this context, extravagant means the propensity to spend/splurge, impulsive means the willingness to make decisions based on incomplete information, sentimentality means the tendency to be affected by emotional stimuli, and sociability means the propensity to join groups and feel attached to others.
Do you see yourself in there?
My take: The first two items make sense. Extravagance and impulsiveness aren't quite the words that I would use in describing growth-stock fans, based on my conversations with (quite literally) hundreds of growth-style portfolio managers over the years, but they correlate with my general impressions. Those are aspects of a broader personality trait.
The second two items … hmmm. They may well be correct. Far be it for me to critique the output of TCI questionnaires, given that I have never taken a psychology class and learned about the existence of the TCI only yesterday--but sentimentality and sociability don’t fit into my growth/value framework. (And I don't have a framework for large/small preferences; if those investors who purchase large companies differ from those who like smaller firms, I have not noticed that distinction.)
Faith vs. Verification
In my experience, growth-stock managers are optimists. They believe that the US is the greatest country in which to live, that now is the greatest of all times, and that their companies will do great things. They pay higher stock-price multiples for their purchases than do other investors, in exchange for getting something better. So, they must have faith; if they do not, they would cease to be growth-stock owners.
This faith leads to trust. Much more than value-stock managers, growth-style managers rely on what corporate executives tell them. (Frequently, when interviewing growth managers, I would ask them to discuss why they bought a stock, and they would respond by repeating back to me the company's public-relations message.) Whether that makes them sociable or sentimental as those terms are used by the "Personality Traits" paper, I do not know, but it does make them extroverts.
And yes, I would agree that growth-stock managers tend to be extravagant and impulsive. The first occurs by definition--they do indeed spend more! The second also follows quite directly from the premise. Growth-stock owners invest in the future; they pay high prices now to receive a high payoff later. They purchase hopes and dreams. They have no choice but to be impulsive, in the sense of making decisions based on incomplete information, because that is what buying the future entails. The task is not for those who require precision.
It would be a stretch to call value managers pessimists, in the attempt to make the contrast between them and growth-stock buyers symmetrical. Pessimists don't buy stocks, for the most part. Rather, value-stock buyers are skeptics. They do believe that happy days will come again, thereby boosting the prices of their holdings, but they lower their expectations. This is not necessarily the best of all possible worlds, and their companies are not necessarily great. Pretty good is enough.
Value managers invest looking backward, not forward. They do not know what the future will bring to their companies, but they do understand how similar investments have fared in the past. They are market historians and are far, far likelier than growth-stock managers to follow the academic literature. (The next finance professor I meet who is a growth-stock investor will be my first.) Value investors are data-driven.
This means that they don't place much faith in corporate executives. Why would they? If a company has been well managed and operates in an attractive industry, it almost certainly will cost more than a value manager is willing to pay. Value investors hold businesses that have broken their promises or are dragged down by occupying an unprofitable sector. Perhaps those companies' executives can offer useful guidance--but best not to take too much from them. Trust history's odds instead.
People Do What They Want
The authors conclude by suggesting that their observed personality-based preferences can help to explain why value-style and smaller-company stocks have enjoyed higher returns, over time. Perhaps the existing asset-pricing models should be revised to accommodate these traits. It may even be possible to accomplish that task while retaining the assumption of rationality.
My conclusion is less theoretical. People are going to do what they wish to do. For most investors, the link between personality and investment style is immaterial - they will own a handful of broadly diversified funds, and thus their portfolios will not strongly tilt toward a particular style. Those of us who are more interested and involved as investors, however, will likely end up following our preferences.
I know that I have. My portfolio shades toward value. If you regularly read this column, your portfolio probably does, too. I would be surprised if I had many growth-stock investors as readers. We might do well in marriage, to the extent that opposites do indeed attract, but not so much with investment matters.
This column was originally published on Morningstar.com, September 5, 2017.
