Comparing JIVAX to SPY Performance

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 investor’s 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 as follows:

· Starting price: 22.42

· Ending price: 29.55

· Return over time period: 31.8%

The return to the S&P 500 over the same time period is as follows:

· Starting price: 1,211.92

· Ending price: 4,343.24

· Return over time period: 284.69%

4) What could be the reasons for the difference is performance for JIVAX and S&P 500? What suggestions would you make for improving the performance of JIVAX?

The reasons for the difference in performance for JIVAX and S&P 500 is that JIVAX is actively managed while the S&P 500 fund is passively managed. Over time, passively managed funds tend to outperform actively managed funds, simply because active trading is extremely difficult as it requires making predictions on what the market will do.

Ironically, JPM tries to exploit behavioral bias, but what is to say that its own fund managers are free of behavioral bias? What is to prevent them from overconfidence bias, herd activity bias, loss prevention bias, or any other type of behavioral bias in the marketplace? Just because they can identify the biases in others does not mean they have rooted them out in themselves or in their own strategic approaches to trading. Rooting out bias is almost impossible.

The fact is, however, that JIVAX and SPY were closely correlated from 2005 to 2015. Then divergence widened, SPY roared higher over the ensuing six years, and JIVAX traded relatively sideways, range bound over the same period, never managing to achieve new highs.

What accounts for the divergence? One factor could be the emergence of retail investors seeking to put funds into passive funds that are well known, such as SPY. JIVAX being relatively less well known compared to the big indexes like S&P and Nasdaq, is less likely to attract business from retail investors. Retail investors have largely come online in the past few years thanks to apps like Robinhood, which debuted in 2013 but has steadily grown in business ever since.

Robinhood allowed retail investors to trade without commissions, which revolutionized the business. Prior iterations for retail traders, such as ETrade and other platforms still charged commissions. Robinhood made money by selling order flow to firms like Citadel. Retail investors liked that they could trade shares as often as they wanted without paying a commission. This sparked a frenzy of retail trading activity. Because retail traders are generally guided by noise and are not as sophisticated as professional traders, their trades tend to be focused on big names, like indexes like the SPY or names like TSLA.

Soon, other platforms such as ETrade, Fidelity, TD Ameritrade, Charles Schwab and others began offering commission-free trading for retail investors, as well. This meant that an entirely new field of money was coming into the market that was actively managed by retail investors, who, ironically, were looking in many cases for passive funds where they could place their money.

With millions of new investors coming online and controlling their own money from 2015 onward, the idea of discovering overconfidence, herd bias, or loss aversion bias likely became much more difficult to do. The volume of traders had grown substantially, and these traders were now taking cues from serious-minded non-professionals, on forums. The pattern of trading became more sophisticated as well, as day trading grew. Retail investors began exploring options more heavily, and a small group of retail investors triggered a massive gamma squeeze on Gamestop to send the stock soaring. They managed to squeeze other stocks like AMC and BBY as well. It was such an alarming condition in the market that the SEC began to get involved to monitor the situation. To deal with the GME squeeze, platforms like Robinhood and others even had to ban the buying of certain stocks to prevent the squeeze from continuing. Hedge funds like Melvin Capital lost billions while retail investors made millions in some cases (others of course lost). But this illustrates the point that a new trading environment developed between the years of 2015 and today that has gotten quite sophisticated as retail traders have learned more and more about the market and how to play it to their own advantage.

Additionally, from 2016 to 2020, when the divergence between 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.