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A lesson in bias?

10 October 2017

What’s in a name? Recent research by 7IM highlighted an interesting if improbable trend, says Ben Kumar, Investment Manager, and a potential lesson in bias

Stepping back and looking at investments from a helicopter view always yields some interesting trends that aren’t always apparent when you’re studying individual companies, industries, sectors and geographies or even funds as part of the investment process.

However, we recently reviewed the top ten largest companies globally from a market capitalisation perspective on the back of some research we ran into FAANGs and how these stocks (or Facebook, Amazon, Apple, Netflix and Google – or Alphabet Inc, to give it its listed name) have contributed some 29% to the S&P 500’s performance in 2017. Remove these and the S&P500 is ‘only’ up by around 9% − a value far more in line with company earnings growth.

Together, these four firms are now valued at over US$1.5 trillion. Putting that into perspective, that’s about the same as the entire Russian economy. And tech stocks leading the rest of the index isn’t new – the FAANGs also led the market in 2015.

But when we looked at those top ten names globally, something else jumped out:

Three of the top five companies begin with the letter A! Looking down the list, we can pick out another A, a B, an E and an F. In fact, among the top ten largest companies in the world, only one company has its first letter in the second half of the English alphabet – Tencent. A crack in the efficient markets perhaps? Imagine if it was that easy to get a leg up in business: a quick name change and your stock price soars! I’d always thought that company names would be randomly distributed alphabetically; that appears not to be the case.

Of course, Tencent is predominantly being bought by investors reading its name in Chinese characters (腾讯). Here I am reliably informed that the first and important part of the character (月) by which it’s ranked puts it at 74th of the 214 radicals or character components. So, yet again it’s in the first half of any Chinese listing. Of course Tencent’s original name in Chinese translates to ‘Soaring Information’ – high in an ambition that looks to set aside any benefits from an alphabet ranking!

Following on from my train of thought, we then looked at the S&P 500. Of its 500 stocks, some two thirds (328) have names that begin with letters in the first half of the alphabet and 42%, (211) are in the first quarter of the alphabet i.e. A to F.

There’s been some academic work already on this front to back this up led by Jacobs and Hillert, two renowned finance professors from Germany’s University of Mannheim. And although that focuses more on the volume of stock trades rather than company size, they determined that “a higher alphabetic ranking provides stocks with higher share turnover, investors with lower transaction costs… [and that] these phenomena are strongest for firms [that are] disproportionately traded by individual investors.”

This clearly doesn’t result in a free lunch. Just branding a business “AAAA” isn’t going to suddenly mean that you’re suddenly leading the world’s biggest company. However, it gives a fresh insight into Google’s change of name to Alphabet in 2015. If there is even the smallest informational advantage to renaming, I’d hazard a guess that the brains behind Google found that out and looked to capitalise on it.

Now while this research probably doesn’t help many of the paraplanners reading this. However, I do think that it spells an important lesson in research and whether or not there are other biases – conscious or otherwise. Does your approach lead you to look at specific investment houses over others when researching for investment options for clients? Perhaps this is where we should be ranked as 7IM rather than Seven Investment Management!

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