Portfolio Managers Are Victims of Bias, Too

Behavioral portfolio management, on the other hand, posits that it's the irrational investors who dominate the market, and that portfolios based on the price distortions their emotions and biases create result in returns that are superior to corresponding indexes. The theory divides financial market participants into emotional masses on the one hand; on the other are investors like Howard, who "ruthlessly drive the emotions out of investing" and seek to harness the distortions created by social validation, short-term loss aversion and all the other emotional reactions and behavioral biases.

Of course, Howard and his team also pay careful attention when researching and selecting their stocks, and though they're behavioral portfolio managers, their analysis is highly quantitative.

"We look for dividend paying stocks," he says, "because if management commits to dividends, you know they're putting their money where their mouth is, and we're interested in commitment to an action because that's very relevant."

Howard also looks at analysts' projections for future earnings and whether they will support and justify the current price of a particular stock.

Beyond that, though, his approach is radically different from most other investors. "I look for the worst balance sheets among a group of stocks, and that's where I lose everyone."

But, he says, balance sheets really have nothing to do with a company's performance, and because most people take them into consideration, therein lies an emotional pitfall that he as an investor can take advantage of.

"We also look for companies that have as much debt as possible–because most people think debt is bad, and that's a measureable proxy of their vision that we can find and build a portfolio on," he says.

Although specific events that trigger crowd responses may be short lived, the emotions they result in are long-lasting and give way to distortions that are both measurable and persistent.

All the same, it's not easy to build a portfolio based on behaviors, Howard says. It calls for an investor to really go against the grain, which is very difficult to do since even investors are affected by the need for social validation. Of course, it goes without saying that convincing investors of the validity of AthenaInvest's approach is extremely tough and a constant work in progress.