First, let me start off with the disclaimer that while I was a managing director at a multi-billion dollar hedge fund for eight years, I have never actually run a firm.  That being said, I have personal relationships with portfolio managers and analysts at many of the world’s largest hedge funds and believe that most of the leaders of these investment firms do at least one thing very wrong: they do not recognize the importance of their own moods.

There is a tremendous amount of academic research on how mood impacts investing decisions.  When we are happy, we are more inclined to take risks.  When we are euphoric, we can become overly impulsive and overconfident.  When we are sad, we become more risk averse.  When we are depressed, we tend to want to change our lives.  This can result in irrationally undervaluing what we own and overvaluing what we do not have.

A firm’s overall mood fluctuates in correlation to how well or badly it is performing.  When a firm is doing well, the firm’s analysts and portfolio managers will be happier and will ordinarily take on more risk.  Similarly, when a firm is doing poorly, these same employees will be sadder and more risk-averse, all things being equal.  Because markets tend to follow boom and bust patterns, this is usually the opposite of what they should be doing.  Leaders should take advantage of their influence to actively regulate mood swings.  Academic research suggests that the mood of a leader of any group is extremely contagious.  A leader’s mood quickly gets transmitted throughout the rest of the organization.  Therefore, leaders should proactively lift spirits after losses and be more morose when business is going well.  They should put the focus on mistakes and the role of luck during the good times, and on what is being done well during the bad times.  Most CEOs and CIOs do the exact opposite.  They usually make employees feel even worse than they already do for losses, and they overly praise employees for good decisions.  Instead of regulating mood’s impact on rational decision-making, they amplify it.

If you liked this post, you may like my recently published book: The Emotionally Intelligent Investor: How Self-Awareness, Empathy and Intuition Drive Performance.