CBT, or Cognitive-Behavioral Therapy, is one of the techniques of choice for multiple situations from anger management to coping with anxiety disorders, cognitive biases and many others.
It has a very interesting and unique use in the specific case of portfolio management – even to the level of individual trades.
Many portfolio managers deal with specific bias. This is natural and endemic to their positions. Regardless of industry, allocation sizes, research style and investment strategies, there is always a level of bias in the investment process. This is not a problem.
The problem is when the portfolio manager starts to doubt their methodology or make emotional moves on drawdown situations, a down quarter, or even personal stress.
Sensitivity to Events
Besides intense 1-on-1 sessions to unearth stressful events, and even traumatic ones in extreme situations, ranging from an argument with the spouse to the death of a loved one, CBT is a welcome technique to continue the discovery and eradication of cognitive biases.
Many events from our everyday lives might affect us. They may causes us to seek safety and make conservative choices, to become irritated and make snap judgments, and many others. These are especially dangerous when your actions have direct consequences on your P&L sheet.
The work of performance coaching with portfolio managers, or even individual traders, is mostly focused on unearthing cognitive and emotional biases so that the person can become immune against them. Simple things such as learning to take a step back when you’re in an emotional state or seeing the upside when you’re only seeing the negative elements are important.
Without this “protection” that CBT provides, you will be a slave to your emotions. Naturally, some people are less resistant than others (the Neuroticism trait of the Big Five personality model in psychology).
Case Study: Safety Seeking
One fund manager that I worked with suspected that one of his PMs had problems letting go of losers. His P&L sheet for the quarter was pretty much zero because, despite the good bets he was making, he was letting losers run and make up for it. He was adhering to the opposite of the old adage of cutting losers and letting winners run.
I worked with Matthias. The first sessions were though. He did not want to open up, not feeling comfortable with having someone pry into his investment process, and more than that, his personal life. We worked on building a relationship and gaining trust.
After some sessions, initial suspicions that Matthias was a somewhat negative person by nature were confirmed. Having had a rough childhood, Matthias frequently felt unsafe. It was now clear these needs to feel safe were manifesting themselves in not having the courage to cut his losses. While he articulated well with analysts to vet and adopt ideas with no hesitation, he had trouble leaving positions that were well past their prime.
Maintaining a CBT journal was a key part of the cognitive tuning process. First of all, Matthias needed to extensively describe all he was thinking and feeling. All the thoughts that were triggered by threatening situations, like conflict, and emotions like fear, anxiety, discomfort suddenly became explicit and on paper.
Next, we started to analyse and judge both these cognitions and emotions. Attacking thoughts like “I will be attacked in conflict” and feelings like “I feel anxious and discomfort with a possible argument” revealed that Matthias was “taking out” his lack of security on his trades. By refusing to let his feelings out and avoiding conflict, he was starting to avoid all kinds of reality checks that might hit him in the stomach, and included in those was the act of analysing which trades were clear losers.
After gaining the habit of journaling and analysing both his cognitions and behavior, Matthias made extensive progress in cutting losses and seeing the upside of his trades as well. By remaining objective, seeing the positive side besides the negative, and having the courage to constantly face the brutal facts, Matthias’s book rose to double-digit growth in two quarters. Although the process was not relatively fast, in absolute terms, deep work was done, and the effect was lasting.
Conclusions
Although this specific approach tackled negativity and the lack of capability to cut losses, it is used for other situations in a very broad spectrum. We have been using CBT in support of coping strategies for traumatic and emotionally intense situations, to deal with anger management, to deal with anxiety and “jittery” trading, and other unproductive patterns in portfolio management.
It is even used as a part of a larger coaching strategy to align analysts and traders when both sides are not working synergistically, preventing optimal results.