To be good or to be better: asset managers’ attitudes towards herding

Abstract

Based on a questionnaire survey this article distinguishes between herding asset managers who try to be good, and nonherding asset managers who try to be better than their competitors. It provides evidence for reputational herding and discusses herding managers’ working effort, preferred sources of information and investment horizon. Additionally, their risk-taking behaviour, including their investment behaviour in short-term tournament scenarios, is analysed. It is found that herding managers assess themselves as generally more risk averse than nonherding managers, but in the tournament they are willing to take more risk. This finding is ascribable to their fear of falling out of the herd.

Acknowledgements

I would like to thank Michael Melvin, Lukas Menkhoff, Marina Nikiforow, Maik Schmeling, John T. Scruggs, Itzhak Venezia and the participants of the European Financial Management Behavioral Finance Symposium 2006 in Durham for helpful comments. Moreover, I appreciate the very useful supporting letter of the German Investment Association ‘BVI Bundesverband Investment und Asset Management e.V’. Financial support by the ‘Wissenschaftsförderung der Sparkassen-Finanzgruppe e.V.’, the research promotion arm of the German savings bank organization, is gratefully acknowledged.

Notes

¹ Regarding incentives, asset managers should also be aware of the fact that reputational (career) concerns might have a significant effect on their remuneration later in their career (see e.g. Fama, 1980; Lazear and Rosen, 1981; Holmström, 1999).

² Here, nonherding should comprise both, anti-herding (i.e. observing the herding and doing the opposite) on the one hand and ignoring the herd on the other hand.

³ We have to mention here that asset managers could theoretically also try to improve their professional reputation by intentionally deviating from the herd (i.e. by signalling personal capabilities and investment competence), but this strategy requires far more effort and its success is more uncertain (see e.g. Prendergast and Stole, 1996). Hence, we will focus on reputational herding henceforth.

⁴ Apart from reputational concerns, Massa and Patgiri (2007) additionally analyse the influence of managerial compensation as a trigger of mutual fund managers’ herd behaviour.

⁵ Similarly, Hong et al. (2000) as well as Lamont (2002) find that inexperienced forecasters deviate less from the consensus forecasts, but when they become older and more established they tend to make bolder forecasts to manipulate assessments of their ability.

⁶ Spurious herding can, for example, be a consequence of changes in benchmark index composites, as discussed and empirically found in the German mutual fund industry in Walter and Weber (2006).

⁷ Herding is not only a phenomenon of developed asset management markets, but it is also observable in emerging markets like e.g. the Chinese fund industry as it is unveiled in Zhangpeng and Rahman (2005).

⁸ See footnote d in Table 7. Here, we consider the same settings and assumptions especially regarding the utility function for gains and losses like in Tversky and Kahneman (1992) in order to make the results comparable. Accordingly, we find that the analysed investment professionals are less loss averse than the individuals in Tversky and Kahneman (1992).

⁹ They also refer to the evidence in Chevalier and Ellison (1997); however, we have to assume here that the fund performance is only ‘a few points ahead’ of the benchmark, but not ‘well ahead’ to bring H9 in line with Chevalier and Ellison's findings. From our point of view, Chevalier and Ellison's differentiation is not practicable in a written survey as the separation between ‘a few points ahead’ and ‘well ahead’ would individually be interpreted, whereas the differentiation between under- and outperformance is consistently understood.