JPM Case Study

1) Briefly describe the money management business of JPM.

The money management business of JPM provides products, such as mutual funds, and wealth management services for clients. Its asset management business may provide products for investment, and its wealth management business may focus on recommendations for which products to invest in, and what investment decisions should be made. JPM offers numerous different funds for investors, such as the intrepid value fund, which looks to exploit behavioral biases in the marketplace to obtain superior returns.

2) Identify 3 behavioral biases that JPM hopes to exploit, and how they can be exploited to obtain superior returns?

Three behavioral biases that JPM hopes to exploit are overconfidence bias, loss aversion bias, and herd behavior bias. Overconfidence and loss aversion are two behavioral biases that JPM looks to exploit when identifying value and momentum anomalies. Another is herd behavior bias, which is largely seen in bubble and meme stocks today.

Overconfidence bias can be exploited to obtain superior returns because it is the tendency in the investor to think of himself as better than he actually is. Overconfidence is common among investors and it means they in general do not manage risk effectively. The problem is that this leads to rash and poor decision making. An example of this is an investor who has a thesis that is actually right but thinks he can time the market. Timing the market is impossible, but because he is so confident he believes he can do it. He puts everything into a one-sided trade without hedging, and now he is vulnerable to the market fluctuations. The JPM fund can use derivatives and short selling or buying to take the other side of that trade and capitalize on the investors overconfidence as he is now stuck in that position waiting for the market to move in the way he anticipated.

The other side of overconfidence is loss aversion. This is where investors seek to take almost no risk at all. If there is no risk then there is little gain. Investors are more concerned about losing money than they are about obtaining alpha. These people are savers rather than investors and they do not even realize how inflation can erode their savings. Investors who have loss aversion can be exploited because they are likely to have stop losses that can be triggered in a flush-out.

The herd behavior bias can most easily be exploited when there is a giant surge in a share price, as happened with GameStop, some cryptocurrencies like Doge, and EV stocks like Rivian and Lucid. The stock is climbing as more and more people buy into it without considering value, and suddenly it is overvalued and can be shorted. Or calls and puts can be bought and sold to take advantage of the high stock price that will plummet when the herd turns against the stock and the momentum reverses in the other direction. Meme stocks are great examples of herd behavior and the run up is almost always followed by a run down just as quickly.

3) The fund created by JPM to exploit these biases is described on their website.

The return to the fund from Jan 31, 2005 to now is...

…JIVAX and SPY was largest, Trump was in the White House, and monetary policy was relatively easy, with Trump consistently leaning on the Federal Reserve to keep rates low so that investors would not be spooked by rate hikes and adopt risk-off positions, which would in turn lead to a market downturn. Trump was seen as very market friendly by investors, and, again, this likely led to more investing in big name funds like SPY than in lesser well known names like JIVAX.

As retail traders are, in general, beholden to big name tickers like SPY or TSLA or AMZN or FB, there is less interest in moving into names that do not have a cult following so to speak. Hedge funds have been following the herd mentality of retail investors in many ways and have helped turn TSLA, for instance, into a cult stock that is valued more highly than the top three car companies in the world combinedeven though TSLA has but a fraction of their market.

There may not be anything more rational to the divergence but the arrival of retail investors coinciding with loose monetary policy (made looser in 2020). For now, the market appears to be being driven by a few big names, which are in all the major indexes or portfolios of fund managers. So long as there is no catalyst that would drive them down significantly, the markets have maintained an even keel. But the gap between SPY and JIVAX suggests that the demand for one has been much stronger than the other and that retail investors are looking to ride the momentum…