Before the dotcom bubble, academic finance was slow to acknowledge the link between investors’ behavioural biases and financial markets. However, the field of behavioural finance is now well established and identifies two main areas of significance concerning systematic investing. First, there is a substantial body of evidence showing how difficult it is for non-systematic fund managers to make consistently reliable forecasts and decisions about investment risk allocation.
Second, there is an acknowledgment of these psychological biases’ effect on financial markets and the consequent opportunities for systematic investors in global markets. This can be evidenced by the fact that humans are risk-seeking when it comes to the opportunity to make very large profits (lotteries) and generally avoid the small probability of very large losses (insurance products). Furthermore, individuals will rely on relatively little historical information to make predictions with high confidence (the law of small numbers). They will tend to be overconfident about their forecasting abilities and are generally overly optimistic. These same behavioural biases are typical of non-systematic investment processes.