How the human instinct to repay hospitality can undermine investors

Tens of thousands of years of evolution mean we instinctively want to reciprocate favours – a largely admirable trait that can be deeply unhelpful when it comes to investing


Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

Behavioural biases are mental rules of thumb or short cuts developed over many millennia where the human brain sacrifices intellectual rigour for the sake of reaching a speedier decision.

So crucial to helping mankind survive and thrive over all the time we have existed on earth, however, they can be surprisingly unhelpful in financial matters and often lead to poor investment decisions.

‘Herding’ is perhaps the most obvious example – the human instinct to follow the crowd will have kept many of our ancestors out of the jaws of a sabre-toothed tiger and yet, in more recent times, has been a root cause of every single stockmarket bubble you care to mention.

There is a close relative of herding we have yet to cover on The Value Perspective so let’s put that straight now and introduce the idea of ‘reciprocation bias’.

Reciprocation bias

If a friend invites you round to dinner, it is almost certain you will invite them back at a later date – it is good manners and, as it turns out, hard-wired into the human brain.

According to anthropologist Richard Leakey, for example, reciprocation is the foundation on which our species has evolved.

“We are human because our ancestors learned to share their food and their skills in an honoured network of obligation,” as he put it.

When you start to think about it, it becomes clear reciprocation is tied up in some of the largest drivers of human life – not least love and hate. Clearly marriage is based on various forms of reciprocation – and the consequent feelings of being nurtured and loved. Similarly, many wars and other conflicts will have their roots in some element of reciprocation that has then escalated badly.

Once you are aware of the idea of reciprocation bias, you can appreciate there are ways it can be potentially unhelpful or even abused.

A good example of the latter is the salesman’s ‘concession’, which US psychologist Robert Cialdini illustrates through the unlikely medium of a boy scout.

Beware the boy scout salesman

Walking down the street one day, Cialdini was approached by a 12-year-old boy who asked if he wanted to buy tickets, costing $5 each, for the annual Boy Scouts Circus being held that Saturday night.

Not wanting to give up his Saturday night to this prospect at any price, Cialdini declined – at which point, the scout asked: “If you don’t want to buy any tickets, how about buying some of our chocolate bars? They’re only $1 each.”

Shortly afterwards, Cialdini realised something was amiss for four good reasons, going on to explain: “I do not like chocolate bars; I do like dollars; I was standing there with two of his chocolate bars; and he was walking away with two of my dollars.”

Later on, Cialdini arrived at a rule to explain this kind of behaviour: “The person who acts in a certain way towards us is entitled to a similar return action.”

Two consequences spring from this – we feel obliged to repay favours we have received and we feel obliged to make a concession to someone who has made a concession to us.

Even though Cialdini was interested in neither the tickets nor the chocolate, once the scout had made a concession – moving from a larger request to a smaller one – he was obliged to do likewise. In effect, the chocolate was the lesser of two ‘evils’.

Harmful to investors

Clearly, then, there are all manner of ways reciprocation bias can be potentially unhelpful to professional investors – for example, when a broker rings up with investment ideas that you do not like.

The first idea may be easy enough to dismiss but, each time after that, the way the human brain is wired make it that little bit harder to turn down.

Then there are the relationships fund managers have with the teams running the businesses they own.

Once again, there may be times when they ask for something – to buy more of the company in the good times, say, or not to sell up during the bad – and thousands of years of instinct start nagging away.

And that is the point – simply being aware of a behavioural bias as an investor does not automatically make you immune to it.

What you can do as an investor, however, is to aim to work to a process that helps to take as much of the human emotion and instinct out of buying and selling companies as is humanly possible.

And by focusing on the numbers in order to unearth unloved businesses with strong balance sheets, this is something at which value investing has been excelling for more than a hundred years.


Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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