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Under the influence – Human beings are instinctively social, which is not helpful in investment

07/10/2015

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

Of all the cultural gifts France has bestowed upon the world, canned laughter is perhaps the most improbable. Yet it was the French who pioneered the practice of giving away tickets to musical and theatrical performances in return for the promise of enthusiastic applause – the idea being that the rest of the audience would be encouraged to follow suit. 

In 1820, two entrepreneurs opened an agency in Paris to manage and supply groups of professional applauders on ‘claqueurs’ and, within a decade, the industry had diversified into such specialities as ‘pleureurs’, who would cry on cue, ‘rieurs’, who would laugh loudly at the right moments and ‘chatouilleurs’ – literally, ‘ticklers’ – who could be relied upon to keep the audience in good spirits. 

What these entrepreneurs instinctively understood was the principle of social proof, which is examined by the US psychologist Robert Cialdini in his book Influence: Science and Practice. At its essence, social proof revolves around the idea that when human beings do not know the correct response to a situation, they will often look to other people for an indication of what to do. 

This instinct to trust in and follow the example of other people can actually be quite a useful one as it helps us to learn to avoid potentially dangerous habits, such as running out into the middle of a road without checking for traffic, and to avoid potentially embarrassing ones, such as modelling your table manners on Henry VIII. 

Unfortunately, however, the principle does not always work in human beings’ favour – from people attracted into a nightclub by an owner who has paid people to stand outside in a queue to make it look more popular than it actually is to people lured into a cult by … well, cults can live – and die – on social proof. 

Social media also thrives on the principle – from enthusiastic, if suspiciously similar, reviews of hotels and restaurants on the likes of TripAdvisor to sites such as Facebook, before whose existence you never knew you could not get through your day without knowing which cereal John had for breakfast or what new toy Mary just bought for her cat.   

An extreme example of social proof gone wrong concerns a 1964 murder in the New York borough of Queens when no fewer than 38 of the victim’s neighbours saw something suspicious. Every single one of them concluded – wrongly – that if something was seriously amiss, someone else would have called the police. Nobody did and so the unfortunate woman died. 

Studies have since revealed the power of this phenomenon, concluding that where an emergency is witnessed by one bystander, assistance is summoned 85% of the time. When the number of witnesses rises to five, however, assistance rates fall to just 31% – a rather more serious manifestation of the idea of ‘pluralistic ignorance’ we last encountered on The Value Perspective in Strangers on a train

In all this, there would appear to be some clear parallels with the world of investing, the first of which involves the behavioural finance bias of ‘herding’. The principle of social proof is another indication that human beings are instinctively consensual – that, in order to survive as a species as long as we have, we have grown used to buying into certain social norms. 

As we have suggested a number of times in the past though, the instincts that may have helped to keep us out of the jaws of some large-toothed predator 50,000 years ago do not necessarily serve us so well when it comes to investing today. Simply being aware of that should be an advantage, however, and value investing has certainly proved that going against the crowd can be a route to outperformance. 

Another parallel with investing is that the principle of social proof tends to fall down at times of high uncertainty – when everyone is looking to everyone else for an indication of what to do. That may help to explain very large drops in the market – investors are running around trying to sense some sort of lead from someone else – and indeed, for the same sort of reason, very large rises in the market too.                                             

Our final parallel links back to the reduced chances of reaching the right outcome when five people witness an emergency – in that instance, somebody realising they should dial ‘999’ – compared with when a sole bystander does. The ability and willingness to think independently is as important in investing as it is in many other areas of life. 

As it happens, Cialdini has some advice on how to improve your chances of receiving emergency assistance should, for example, you fall ill in the middle of a crowd. Instead of crying for help in general, he suggests your best chance is to identify an individual: “You sir, in the blue jacket, please call an ambulance.” And if you recognise the power of independent thought and are looking for somewhere to invest your money? “You sir, in the jacket with the ‘TVP’ monogram …”

Author

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

I joined Schroders in 2015 as a member of the Value Investment team. Prior to joining Schroders I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst. 

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