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Good News for Investors Affected by Framing Bias

When we formed Sunpointe, we chose the name because one of our goals was to “shine a bright light of transparency” on investment products.  My perspective on the new SEC fund disclosure rule is below, but first – the behavioral reason regulatory updates like this are so important.   

A few weeks ago I gave a Behavioral Finance lecture to a group of Masters in Finance students at Washington University in St. Louis.  After an introduction to the topic, I opened the floor to questions.   The focus of the talk was the individual biases that I have identified and reviewed over the years.  The professor effectively interviewed me based on the content of my books regarding the biases.  When I do this, it gives me a chance to take a fresh look at them.  

One of the more impactful, yet underrated biases that I reviewed during the lecture was framing bias.  Framing bias refers to the way in which a decision-maker will respond to a situation differently based on the way in which information is presented to them – i.e., framed.  In choice contexts, a decision-maker has flexibility in how to think about a problem.  Framing can be explained pictorially.   For example, look at figure 1.  Which line is longer?   

Figure 1. 

 

Many people think that the bottom line is longer.  This is due to framing effects.  Now look at Figure 2.  Which line is longer?   

Figure 2. 

Everyday examples of framing bias occur at the grocery store.  Many grocers will price items in multiples such as 2 for $2 or 3 for $7.  Have you ever found that sometimes when you purchase only one of these items, the price is simply the total price divided by the number of items (such as $1 in the case of 2 for $2)?  The store is taking advantage of people’s susceptibility to framing.   Good salespeople know this, and when there are many ways to look at a problem, they will frame a solution for a buyer in a way that is favorable to the salesperson’s product. 

I bring up framing this month because I just learned that the SEC is finally addressing an ongoing pet peeve of mine.   In a four-to-one vote this week *, the agency’s commissioners approved a rule that requires a fund to invest at least 80% of its assets in line with the focus suggested by its name. A “growth” fund should mostly own growth stocks; a “value” fund should own value stocks.  “This is basically about truth in advertising,” said SEC Chair Gary Gensler in recommending approval. 

Under the rule, fund prospectuses will have to define the terms used in a fund’s name and explain the criteria that managers use to select investments that fit the name. Those criteria must become part of the fund’s official investment policy.  The SEC hopes that requiring funds to explain their names will help investors understand what fund promoters mean when a name mentions “big data,” for example, or “artificial intelligence.” One fund’s definition of “green” may differ from another’s, but investors will be able to see how each one uses the term. 

This is very good news for investors who are subject to framing bias. Let’s face it, we as consumers tend to believe what we read on packages and take actions based on what we’re reading. For many years, I’ve thought that fund names were accurate in some cases, but highly inaccurate in others. And this is because investors expect that if they buy a value fund, for example, it actually has value stocks in it.   

Ultimately, it’s how situations are framed that determines the course of action.  As an investor, it’s very important to understand what portfolio managers are doing “under the hood” of the funds you invest in.  At Sunpointe, this is our job.  Even as the SEC will now be able to ensure the fund description is accurate, it’s still different from understanding what a fund can do for you and your family. A conversation about framing isn’t just for college students 

If you’d like to learn more about my research into these behavioral biases, please visit michaelpompian.com. If you’d like to have a conversation about how your investments are framed for you and to you, we’d love to talk. Get in touch at sunpointeinvestments.com 

Please let us know how we can be of service.   

 * https://www.barrons.com/articles/funds-names-sec-new-rules-5dcb47a5?mod=hp_LEAD_9