In a recent podcast by CFA Institute, Clare Flynn Levy shares insights regarding the role that behavioral economics plays in investment decisions and the experiences that led rought her to create Essentia Analytics.
In the interview, Flynn Levy notes that the finance industry “rewards people for skill, but performance is a measure of outcome, not necessarily a measure of skill. A lot of luck is involved.” She recounts her own strong performance as a tech portfolio manager in the early 2000s, adding, “but when the market started to downturn and I wasn’t making money anymore, people started asking questions and I started asking myself questions. I really wanted to know how I could maximize my return on the energy I expended.” She founded Essentia to use historical trade data as a means to guide clients in terms of “what they should be doing more of and what they should be doing less of.”
Her firm examines historical trades and the contextual information about those trades (what was happening in the markets at the time) to identify patterns in the types of decisions that were made most often, as well as which had positive and/or negative outcomes. Flynn Levy explains that by “decomposing” clients’ investment decisions, her firm can identify “in what context you add value in any of the individual tasks.”
Two of the more problematic areas for clients, she says, are “loss aversion tendencies” and “alpha decay”—where clients may hold onto a once-performing investment idea longer than they should. She notes, “There’s a ‘sell-by’ date on your alpha ideas, and we can slice and dice and figure that out.”
Flynn Levy compares Essentia’s client base to a patient that “‘goes to the doctor to get your blood work done and walks out of the office with a piece of paper but no explanation or treatment plan. What we do at Essentia is provide a treatment plan.”