The Cult of Emotion

[MachineGhost]

You’ve said many industry best practices are actually  “emotional catering.”?

We talk about the markets as the cult of emotion, which means essentially [that] all prices are driven by emotion.
Very few fundamentals are reflected in prices.  Around that cult of emotion is built an industry that we call the “cult
enforcers.”? Even if I (as an investor) decide to get out of the cult of emotion, I’ve then got to go up against almost all of
the industry practices to do that because the industry has been built around enforcing that cult.

A classic from a legal standpoint is the Prudent Man Rule. That’s a legalizing of the cult of emotion. What’s a prudent
man? The “prudent man”? is the typical emotional investor.

Modern portfolio theory is part of the problem and not part of the solution, because modern portfolio theory is built
around volatility. Volatility is largely emotion. In the short term, obviously, volatility is risk. If I need money in three
months, I do have to worry about that. But if I’m building long-horizon wealth, volatility is largely emotion. If I build
a portfolio based on volatility, which is, of course, Markow-itz’s mean–variance optimization, that’s really short-term
emotion optimization. It’s institutionalized.

Every investment professional in the industry talks about volatility, drawdown, upside capture, downside capture,
the Sharpe ratio (which is a long-term return to short-term emotion), and tracking error. Almost everything they do is
based on modern portfolio theory and has emotion built into it and therefore reinforces the cult of emotion.
Even if I decide as an investor that I’m going to de-emo-tionalize my process, almost every investment professional I
talk to will essentially push me back into the cult of emotion because, “Well, you need to worry about volatility.”? We see
this all the time. It’s really, really a challenge to step away from the cult of emotion.

http://www.cfapubs.org/doi/pdf/10.2469/cfm.v25.n5.10