Herding Behavior in Student Managed Investment Funds

ABSTRACT Student Managed Investment Funds (SMIFs) have grown in number; unfortunately, there has been little research on the efficacy of these funds. We fill this gap by exploring the potential consequences of student investment management. We find that investment decisions are often impacted by herding behavior, which results in underperformance. We further examine characteristics that influence the likelihood of herding, finding that pre-existing knowledge of the company under consideration, as well as amplified time constraints, increase the probability that herding occurs. In contrast, we find that increased education, both general and targeted behavioral education, reduces the likelihood (and impact) of herding. INTRODUCTION In an attempt to prepare students for the "real world," many universities have developed hands-on activities, such as student managed investment funds (SMIFs). While the primary goal is generally to provide practical training, a related benefit is the positive impact such activities have on fundraising and marketing, particularly in cases where fund performance is especially good. Given the rise in popularity and importance of such programs, it is surprising that very little research exists surrounding their efficacy (either internal or external). We suspect, similar to our own situation, that while returns are important, the focus of these programs is primarily educational, often viewing the educational component as being a detractor to fund performance. However, we believe that there is actually an overlap between these areas, as increased education (particularly certain types) should, in fact, improve the investment selection process. With this in mind, one particular aspect we consider is the incidence (and potential reduction) of herding among student investment managers. Prior literature (see next section) documents the existence and impact of herding among investors. Herding is essentially "going with the crowd." Thus, investors end up trading more based on emotion than objective evidence. The result is that performance, in the form of portfolio return, is often reduced. Given the social environment of a classroom, combined with the aspect of investing real money (for the first time in most cases), we believe that student funds may be a fertile environment for such a bias to occur. Thus, we examine the actual decisions made by student investment management teams over the course of multiple years. We document the effect of herding, but, more importantly for SMIF advisors, we identify ways to reduce the behavior and thereby potentially improve the security selection process and, potentially, fund performance. We find that the student investment managers do exhibit herding in many decisions and that the result, particularly in situations where it tends to be most pronounced, is a reduction in investment returns. We further explore what characteristics increase (or decrease) the likelihood of herding within the context of a specific investment decision. We find that general familiarity, as opposed to specific research, with the investment being considered increases the likelihood that herding will occur, as does the existence of significant time constraints. In contrast, it appears that the presence of group members with higher education levels and/or targeted education in the field of behavioral finance decreases the likelihood that herding occurs. Our results suggest specific actions SMIF advisors can take to mitigate the potentially negative influence of herding. For example, advisors could limit the number of trades that are allowed on a given day, thereby setting aside sufficient time for discussion of each trade. Further, requiring student teams to send out recommendations prior to meeting for discussion will provide a richer and more objective dialog by enhancing the variance of opinion. Lastly, including some readings or discussion on behavioral finance may help students recognize, and therefore overcome, potential biases, particularly as they relate to herding behavior. …