Advisers' Corner: What Makes Clients Tick?

• "What makes clients tick?" is an age old question that is constantly producing both new and old answers. A series of papers we recently read is no exception to this rule. In "Amygdala Damage Eliminates Monetary Loss Aversion", De Martino, Camerer and Adolphs describe a study that provides more evidence that the amgydala (a primitive part of our brains that controls our sense of fear) plays a significant role in the generation of human beings’ aversion to loss. Previous research, which we have also written about over the years, has also linked the amygdala to the feelings of fear triggered by heightened uncertainty and social isolation. We continue to believe that studies such as this will eventually lead to a more fully developed "sub-atomic" theory of financial market behavior. Along this same line, another recent article ("A Frightful Genetic Twist" by Greg Miller) reports on other research that found that 30% of Caucasians have an alteration in the BDNF gene that leads to a heightened fear response.

  Speaking of the impact of genetics, in "Genetic Variation in Financial Decision Making", Ceasrini, Jaohannesson, et al ask whether genetic variation can explain some portion of the observed differences in people's portfolio asset allocation decisions. They conclude that genetic variation accounts for approximately 25% in the variation in individual's willingness to take risk and also to engage in returns chasing (trend following) behavior. The authors also note that, due to increasing assortative mating (marrying someone quite like oneself) in societies with widening degrees of social separation, the genetically driven component of risk (and, presumably, loss and uncertainty aversion) may well increase in the future.

  Finally, Bill Bernstein, whose professional training is in neurology, has an excellent article in the January/February issue of the Financial Analysts Journal ("Of Laws, Lending and Limbic Systems"). Given our interest in the neurobiological roots of investor behavior, we were particularly interested in his discussion of the powerful influence of the human nucleus accumbens, which is responsible for our anticipation of future reward. As Bernstein notes, "to label the nucleus accumbens our 'greed center' is not too much of an exaggeration...Although he did not know it at the time, Charles Kindelberger clearly had the nucleus accumbens in mind when he uttered his most famous bon mot: 'There is nothing so disturbing to one's well-being and judgment as to see a friend get rich.'" As Bernstein notes, and as we have written in the past, the critical neurbiological dynamic that underlies investor behavior is the ongoing contest for primacy between the feelings of greed and desire for reward engendered by the nucleus accumbens, and the fear of uncertainty, loss and social isolation produced by the amygdala, both of which occur out of reach of our conscious, rational brain.

  Advisers know that word of mouth and other references from existing clients is a powerful means of attracting new ones. But what triggers powerful word of mouth responses from existing clients? Another recent research paper provides some insights into the answer to that age-old question. In "Social Transmission and Viral Culture", Berger and Milkman report on their study of the articles published in the New York Times that were most frequently emailed from one reader to another. One key driver was the extent to which an article inspired awe. As the authors note, "stimuli that open the mind to vast and often unconsidered possibilities can inspire awe, a unique human emotion that expands a reader's frame of reference. Awe is the emotion of self-transcendence, a feeling of admiration and elevation in the face of something greater than the self. It occurs when two conditions are met: First, people experience something vast: either physically vast such as the Grand Canyon, conceptually vast such as a grand theory or finding, or socially vast such as fame or power. Second, the vast experience cannot be accommodated by existing mental structures. Intellectual epiphanies, natural wonders, and great works of art can all make people feel a sense of awe." Other stories that were frequently emailed were those that were "more surprising, practically useful, emotion-laden, or positive articles."

  Finally, we call your attention to two new research studies. The first is by Angela Hung and Joanne Yoong of RAND. In "Asking for Help", they use a combination of survey and experimental evidence to show that "unsolicited or automatic advice [e.g. required meetings of 401(k) plan participants with financial advisers] has no effect on investment behavior and outcomes. However, individuals who actively solicit advice ultimately change their behavior and improve their performance." The second study is by Andy Terry and Ashvin Vibhakar of the University of Arkansas at Little Rock. They have published a very informative article on "A Comparative Analysis of the CFA and CFP Designations." We highly recommend it to our readers.

| Advisers' Corner: What Makes Clients Tick? | Overview of Our Valuation Methodology | Uncorrelated Alpha Strategies Detail | Global Asset Class Returns | Table: Market Implied Regime Expectations and Three Year Return Forecast | Table: Fundamental Asset Class Valuation and Recent Return Momentum | March 2010 Issue: Key Points | This Month's Letters to the Editor: Changes to Attitutudes About Investing - Mad for Alpha; Does Index/Retired Have a "Black Box" Toward Your Asset Allocation Strategy? | Global Asset Class Valuation Updates Detail through February 26, 2010 | March 2010 Economic Update: Do We Still "Have the Bubble"? | Product and Strategy Notes: Investment Strategies; MSCI Barra - What Drives Long Term Equity Returns; Implications of Algorithmic Trading to Active Management Strategies; and New Products - Longevity Risk Indexes, Disturbing Trends in the ETF Market | Investor Herding Risk Analysis |