PIMCO and the Center for Decision Research (CDR) at the University of Chicago Booth School of Business recently announced a partnership in support of CDR’s behavioral science research, including behavioral economics and finance. In recognition of this investment in research, Chicago Booth’s CDR laboratories have been renamed the PIMCO Decision Research Laboratories and will include a new “storefront” behavioral science research lab designed to deepen public engagement and broaden the reach and diversity of participants in research studies.
In the following Q&A, Richard Thaler, winner of the 2017 Nobel Memorial Prize in Economic Sciences and a professor at Booth, and Emmanuel Roman, PIMCO’s chief executive officer, discuss the benefits behavioral finance can have on investment decision-making, the asset management industry and society.
Q: Why should investors care about behavioral finance?
Roman: Behavioral finance is an incredible field and offers insights into asset pricing. It can illuminate human error and bias in decision-making and provide decision-makers with tools that can help achieve superior outcomes. The research findings have the potential to make just about anyone a better long-term investor.
Looking at our industry and what we seek to achieve for clients, our goals are to achieve better risk- adjusted returns. We believe that markets on the whole quickly reflect new information and are close to what academics call “efficient.” We also believe, however, there are long-term structural inefficiencies in fixed income markets that make generating alpha somewhat easier than in equities. So asset managers ought to periodically revisit how they intend to outperform consistently over the business cycle and the edge they have over their competitors.
We see two areas that have the potential to contribute meaningfully to outperformance: making better decisions and having differentiated and superior data. The partnerships PIMCO announced in 2018 address these areas. Through our novel partnership with the Center for Decision Research, we look to support and collaborate on robust research that contributes to a deeper understanding of human behavior and decision-making ‒ insights that may complement PIMCO’s existing techniques designed to control biases within our investment process and lead to wiser decisions for portfolios and ultimately clients.Challenging our assumptions has long been central to PIMCO’s culture. At our quarterly investment forums, for instance, we invite distinguished speakers from the worlds of investing, business, academia, public policy, and other domains. Spirited debate is the rule, not the exception, in our internal deliberations, including daily meetings of our Investment Committee, and we inform such debates with the latest research across a spectrum of fields.
In July of 2018, we announced a partnership with the California Institute of Technology (Caltech), the world-renowned science and engineering institute, to explore ways artificial intelligence can contribute to the investment process. We established the PIMCO Postdoctoral Fellowship in Computing and Mathematical Sciences and the PIMCO Graduate Fellowship in Computing and Mathematical Sciences. With this sponsorship, we are building critical links between PIMCO and researchers at the intersection of data science, machine learning and economics. Quantitative analysis has been integral to our investment process for decades, and further investing in this field should help us remain on the cutting edge of this rapidly developing field.
Q: Richard, one topic in behavioral finance that affects everyone is funding retirement, an area in which you have done consequential work. Could you discuss this and where we go from here?
Thaler: A discussion of retirement begins with the broader topic of financial literacy, and how challenging the topic is for many, if not all, people. I would argue, and there is ample research to validate this argument, that while we feel it is useful to educate people about financial topics, in practice such education is of limited value. It’s not that people are dumb; it’s that problems are hard.
Researchers, including myself, and people in the industry have worked over the past 20 years to make saving easier for employees with auto-enrollment and auto-escalation. And employers have introduced sensible target-date funds. As obviously beneficial as this is – and clearly retirement savings have increased as the practice has become widespread – it took years of pounding the pavement to make it happen.
What these approaches have in common is they make it easier for people not to have to think much about the solutions. The next big problem to tackle in retirement is what to do once you get there; we call this decumulation. All the focus has been on how to save enough to retire. But once you reach the appropriate age, how do you stretch out savings over an unknown remaining lifespan? If one retires at 70, savings may need to last 10, 20 or even 30-plus years, and that span can increase further if one retires earlier or has a younger spouse. I believe decumulation is a more difficult challenge than accumulation. My generation, the baby boomers, have begun retiring, and the ones who have managed to build up a nest egg are going to need a lot of help figuring out how to make it last. At least, from my perspective, this is the sort of problem that would be fun to think about.
Q: Another relevant topic for asset managers, and arguably just about everyone working, is organizational management. How might research in behavioral science (which includes behavioral finance) help organizations run more effectively?
Thaler: I have come to believe that human resources departments generally could benefit the most from behavioral science insights. The problem is overcoming institutional inertia. Consider hiring: Why do hiring managers still conduct the traditional job interview? There is ample evidence going back some 40 years that a traditional job interview reveals very little, if anything at all, about how a candidate will perform once hired. If a hiring manager uses a 30-minute chat to ask questions like, “Where do you see yourself in 10 years?” that is not going to predict much. This is status quo bias. There are all kinds of things that we do because that’s the way we’ve always done them, and it’s very hard to change. My suggestion is when you have promising candidates, use interviewing as a recruitment tool to get them excited about working for your company.
After hiring, there are several areas worthy of study and improvement, including coaching. Sports teams are well-known for using data to track performance and, when done right, helping players utilize their strengths. In basketball, for example, they have unbelievable data on how players perform every second of the game, such as how often they make shots from certain positions on the court. An investment manager such as PIMCO could collect and review data on trades and traders and what triggers them to make a decision and what was the result. If you can teach somebody to hit a free throw, you could probably teach people to be better traders. Honestly, I don’t think we do enough coaching in almost any field.
Q: Emmanuel, anything else to add?
Roman: I’d like to return to the topic of wealth decumulation in retirement. To begin, at PIMCO we seek to do more than simply deliver superior investment performance. We partner with clients to find innovative solutions to complex problems, and funding retirement is one of the most challenging problems individuals face. Our client analytics group authored a paper called “Income for the Retirement Years” for U.S. clients on this issue, addressing the questions of when to take Social Security, how to allocate assets and whether to buy an annuity. They share a model that concludes that the mix of stocks and bonds one should hold at retirement depends significantly on an individual’s level of wealth but that the decision to annuitize is relatively consistent across the wealth spectrum, albeit with differing allocations. I recommend reading the paper, and we intend to continue assisting clients with decumulation.
Finally, I cannot stress enough how important it is that asset managers, and really all investors, stay current with research relevant to their areas of focus. This is critical to avoid simply perpetuating what one did before, falling into confirmation bias, missing new opportunities, and potentially being surprised by developing risks. PIMCO and CDR expect to collaborate on a range of research projects across the behavioral science spectrum. Our intention is to bolster our ability to deliver outperformance and innovative solutions to clients.
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