August 12, 2019

Pitfalls that Plague Investment Committees

Investment committees serve as a common structure for the decision-making responsibility in overseeing assets, based on the idea that decisions made by a group of people will be better than individual decisions, particularly when it comes to the complexities of investing. But research shows that it takes more than a collection of people to make wise decisions. Why do some committees generate better investment outcomes than others; is it because they are just better investors, or are there group dynamics at work that can systematically rob a committee of its ability to make strong decisions? Here we discuss some of the pitfalls committees fall prey to that can undermine their long-term outcomes. For more information, read Arnerich Massena’s white paper, Investment Committees: More than the sum of their parts.

Groupthink

Groupthink is a term coined by Irving Janis in 1971, and refers to a group’s tendency toward conformity, which can override critical thinking. All groups are susceptible to groupthink, particularly in more cohesive groups. See the box on the right for eight examples of how groupthink affects teams. Countering groupthink requires vigilance and a balanced approach. Groups should become comfortable with healthy conflict, encourage debate, and invite opposing opinions.

Information sharing, availability, and confirmation bias

Groups function best when they make full use of the complete collective knowledge available to the members. However, groups have a tendency to focus only on the shared information that is already available to them, rather than soliciting the unique information that only one or a few group members may be able to bring to the table. This can be compounded by the availability bias, which suggests that people tend to make decisions based on whatever information is at hand, whether or not it’s the most applicable or relevant.

Further narrowing the information pool, group members also tend to engage in confirmation bias, where the group will seek out only information that confirms their already-existing views and supports their perspectives.

Representation and overconfidence

Representation occurs when a small or single sample is mistaken as being representative of a larger category. For instance, individual experiences of group members may play an outsized role in the group’s judgment. Committees should seek to incorporate outside information and a variety of perspectives.

Individuals are also prone to overconfidence in their own ability to make decisions. Committees, which have the affirmation of the entire group, tend to be even more so. Taking the time to review and evaluate past decisions can give committee members greater perspective.

Group polarization

Groups tend to make more extreme decisions than individuals. The collective momentum of the team can shift the decision to either a riskier or more cautious decision than most members would have chosen individually.

Slow decision-making

When it comes to investing, the market does not move at committee speed and wait for group consensus. One of the greatest challenges for investment committees is managing the team’s decision-making processes efficiently so that portfolio changes occur in a timely manner.

These pitfalls don’t have to plague your committee! To learn more about building a strong investment committee, read Arnerich Massena’s recent white paper, Investment Committees: More than the sum of their parts and listen to the accompanying podcast here.