Behavioral Analysis: Seeing What Is Left Unsaid by Aimee F. Kish, CAIA & Leanne ten Brinke, Ph.D. – TeamCo Advisers


Emoji is widely considered the fastest growing language in the world. Deemed the first truly global vernacular, Emoji has spread dramatically since its creation in 1999. The language consists of static objects, gesturing hands, depictions of actions, and a multitude of facial expressions that are used to tell intricate stories and convey complex emotional experiences. An emoji describes internal, psychological experiences more quickly than verbal explanations and transcend barriers of culture and language by relying on the universal nature of emotions, a concept initially put forward by Charles Darwin in 1872. More recently, research by Paul Ekman and colleagues has established that people globally express emotions with the same involuntary muscle movements1. Moreover, people are adept at interpreting genuine emotional signals; it takes only a fraction of a second to recognize whether someone is feeling happy, sad, or angry, and reading faces often provides information that words alone cannot convey.

The importance of comprehending and responding to nonverbal signals has sparked a science which has grown dramatically in the last 40 years, allowing researchers to decipher not only emotion, but personality traits and credibility from the examination of a subject’s behavior. Behavioral analysis has been leveraged in a variety of domains, from improving interview and interrogation techniques to designing more effective advertising campaigns. In collaboration with researchers at University of California, Berkeley, TeamCo has incorporated behavioral analysis in investment management due diligence. TeamCo believes that behavioral analysis is an insightful addition to the process of evaluating hedge fund managers, as it often exposes key facts and qualities about a hedge fund manager that might ordinarily remain veiled.

Translating Nonverbal Behavior

CASE STUDY: A method known as “thin-slicing” can be used to evaluate both verbal and nonverbal behavior, based on brief interactions (typically no more than five minutes); this method has proven to reveal surprisingly accurate insights about a person’s character and personality traits.2 For example, an allocator conducts an initial interview with a hedge fund Chief Investment Officer in a video-taped session (with consent from the CIO). Rather than focusing on a professional biography, the interview is a conversation about the CIO’s personal background and experiences, which can often reveal more valuable material. Importantly, the allocator can compare the content of the answers with the nonverbal behaviors expressed while answering those questions. Even brief interactions can pave the way for an allocator to assess attributes like wisdom—the CIO’s ability to learn from past experiences—by considering his/her nonverbal behavior as he/she discusses previous challenges. A closer review and analysis of the meeting footage may further reveal a host of behaviors—ranging from vocal tone to brief emotional leakage—that can provide the informed observer with new insights and knowledge needed to accurately assess the CIO’s psychological states and traits.

[drizzle]Due diligence within the hedge fund world is a time-consuming, costly endeavor. There are as many philosophical and methodological variations to conducting due diligence as there are investors, often with an overt emphasis placed on the quantifiable and verifiable metrics inherent to risk and return analysis. Regardless of where emphasis is placed (historical performance, back office structures, governance controls, manager pedigree, fund terms) hedge fund due diligence is an all-encompassing necessity and it is, therefore, incumbent upon hedge fund investors to ensure that resources are allocated wisely. Despite careful screening, the imperfect nature of due diligence and quantitative analysis may allow unwanted high-risk managers to slip through the approval process and into client portfolios. Furthermore, in the world of hedge fund investing, a bad decision can damage a program far more than a good decision can be helpful.

In addition to rigorous quantitative analysis, TeamCo believes that the consideration of certain personal attributes of the hedge fund’s key people is vitally important. Key people control the investment decisions, set the firm’s culture, drive the firm’s day-to-day operations, and are ultimately responsible for its success or failure. Despite this importance, careful investigation of these personal attributes (such as leadership, integrity, and intellect) is a disproportionately small segment of total fund due diligence for most hedge fund allocators. TeamCo posits that the most important form of risk mitigation involves evaluating key people of the hedge fund according to a rubric of psychologically meaningful behavioral criteria.

Behavior analysis takes into account the movements of the face and body and their underlying meanings during social interactions. These expressions can be consistent with what the individual is saying verbally, or they can diverge when a person conceals or falsifies a feeling (i.e. emotional leakage). In a due diligence application, skillful presenters, as are many hedge fund managers, can seem confident, intelligent, and trustworthy on the surface. Yet, when examined closely, can show signs of deception, fear, or other emotions indicating the need for deeper analysis. For example, it is widely known that happiness is revealed by the contraction of muscles around the mouth, pulling the corners up into a smile. Such an expression may occur as a manager states that the numbers for the current month “look good.” A genuine expression of optimism, however, should involve not only muscles around the mouth, but also activation of muscles around the eyes, creating crow’s feet in the eye corners (see Exhibit 1: Falsified vs. Genuine Smiles). In the absence of this telltale signal of authenticity, the statement may take on a whole new meaning.

Behavioral Analysis

In addition to fluctuations in an emotional state, patterns of verbal and nonverbal behavior can provide insight into enduring personality traits and social orientations which can aid in predicting how a person may react when faced with certain obstacles in the future. These potential predictions can affect the due diligence process; in practice, an allocator alerted to confidence in a manager may want to consider probing whether or not the confidence is overstated. This can indicate areas or topics for further targeting. Armed with this understanding of fluctuating emotional states and their connection with enduring personality aspects, one can extract a multitude of meanings from even a brief interaction. For example, one intuitively knows that dominant individuals tend to take control of social interactions; however, the skilled interviewer will be able to identify a dominant individual more precisely based on their behaviors (such as more often interrupting others in conversation, adopting more expansive postures, or expressing their emotions more freely than submissive individuals) as seen in Exhibit 2: Dominating Without Words.

Behavior Analysis in Hedge Fund Manager Evaluations

Louder Than Words

CASE STUDY: The markets have been difficult and an allocator wishes to discuss the changing regulatory environment with a hedge fund’s Chief Operating Officer. During the meeting, the COO exhibits nonverbal signs of gratitude, conscientiousness, and agreeableness (such as smiling with eyes cast downward, using precise hand gestures, and using head nods to indicate agreement). Due to these visible signs, the allocator leaves the meeting more confident in the outcome of their relationship with the hedge fund. Regardless of the subject matter, stable personal traits – amicability in this example – are likely to shine through. “All-star” qualities, such as leadership

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