23 May 2018 2 min read

Behavioural drivers of factors

By Andrzej Pioch , Fadi Zaher

Evolutionary psychology highlights a Stone Age mentality hardwired into our brains and reflected in our behaviour and habits. For example, we tend to organise ourselves into groups in order to adapt more easily to different environments: behaviourally it is far less dangerous to be wrong in a group than to be right on our own. This explains the desire and impulse of an individual investor to follow the crowd.


Research has shown that characteristics common to groups of securities, or ‘factors’, have historically delivered excess returns over market-cap weighted indices (the ‘factor premium’) over the longer term. Example of factors include value, momentum, quality, low volatility and size (small-mid cap). You can read more about factors in our previous blog.

Today we understand that the factor risk premium in these ‘unexplained’ returns is the result of the reward for risk, market structures and behavioural drivers.


Investors’ cognitive biases, which can lead to irrational investment decisions.

Market Structure

Powerful forces that shape investors’ preferences or actions, such as taxes, long-only constraints, among others. These issues are not always addressed in academic research.

Reward for risk

The premium that reflects the higher-risk nature of an asset, which is explained by neither behavioural biases nor market structure reasons.


These three classes of factor drivers can be cyclical – reward for risk is high during volatile markets, which in turn makes investors behave irrationally, which may trigger a stop-loss in the portfolios of larger institutional managers. A particular factor premium may be dominated by different drivers at different points in time.

In this blog we focus mainly on the behavioural drivers of the factor premium. Different kinds of behaviour and biases prevail at different times, which explains why certain behaviours can be attributed to more than one factor. The list of behavioural biases that we mention is not exhaustive, as more than one may explain a particular factor premium at any given time.

For momentum, recency bias effectively says what went up is overweighted in the expectation this will happen again. In such cases, investors could place too much emphasis on recent events, while ignoring the long-term performance of an investment. From a value perspective, it occurs when people more prominently recall and emphasise recent events and observations than those in the near or distant past.

Recency bias tends to exacerbate a stock market downturn in volatile market environments, creating a value premium. If something carries more risk, this does not necessarily mean it will deliver better risk-adjusted returns: the returns may be higher (i.e. above market cap indice) but not necessarily in risk-adjusted terms. Recency bias is a short-term behavioural bias that applies both on the way down and way up (recency bias fades away) for the value factor.

On quality, a lack of interesting stories can partly explain the factor premium. The more information on an investment theme, the more likely it seems to play out. A lack of interesting stories may make investors shun away from quality stocks. Availability bias happens when investors judge the likelihood of an event, or frequency of its occurrence, by the ease with which examples come easily to mind – popular stocks in the press and media tend to get most attention.

Moreover, a person's subjective confidence in his or her judgements is often greater than the objective accuracy of those judgements, especially when confidence is relatively high. Overconfidence bias could lead investors to overweight high risk/high volatility stocks in portfolios. Overconfidence is one example of a miscalibration of subjective probabilities.

In sum, the behaviours discussed here move in cycles as not all investors are alike. Investor behaviour can vary depending on the individual investment strategies, personal experience and risk profile. However, from the perspective of the overall market, it does certainly appear to be the case that you can take man out of the Stone Age, but you can’t take the Stone Age out of man.

In our next piece we will look more closely at how market structure prevents some of the well-documented elements of equity risk premia from being arbitraged away.

Andrzej Pioch

Fund Manager

Andrzej is a fund manager who places a lot of importance on being mindful. He starts the day with a one-mile swim and a cycle to work. In the office, he focuses on multi-asset income strategies and multi-factor equities, and regularly lectures on asset allocation at one of the London universities. With his newly found enthusiasm for running, he now hopes to tick off one of his bucket list goals and take part in a triathlon. Watch this space…! Andrzej joined in 2014 after five years in the multi-asset team at Aviva Investors.

Andrzej Pioch

Fadi Zaher

Head of Index Solutions, Index Funds

Fadi is a master of many trades with his focus across Index, Asset Allocation and Factor Based Investing. This is probably no surprise given his financial experience in the past 14 years ranges from heading up Barclays Wealth’s Fixed Income unit and Kleinwort Benson’s Bonds and Currencies teams, to working at the European Central Bank and even a stint researching and lecturing in finance and econometrics in Sweden. When he’s not honing his financial CV, Fadi can be found in his garden, tending to his plants with a particular fondness for his mint collection.

Fadi Zaher