Human Nature Remains Undefeated

– David Wanis, December 2025

For many people today the world seems increasingly uncertain. What will the role of humans in the workforce be like in 5, 10 or 20 years time? How do we navigate seemingly unique crossroads of society, demographics, culture and technology? And what does it mean for generating superior investment returns?

If I could teach my children only one thing about the world in the future, it would be to focus on understanding human behaviour. This is the one constant in an ever-changing world. When you look back over time, the behavioural aspects of history tend to erode from the historical record at a faster pace than facts. What happened, in which sequence and who the players were, is easier to record than how people felt and what emotions drove their decisions at the time. Investors who lived through the dot-com bubble or Global Financial Crisis have memories of these events which feel completely different to the numbers-on-a-page version recorded in textbooks. Financial advisors observe this firsthand when the difference between a client’s risk tolerance, described when markets are calm, clashes with their true risk tolerance unveiled during the first major drawdown event.

How people feel and their behavioural biases and flaws were as present in ancient Rome as they are in 21st century Australia. We bet this will continue.

We have written in the past about individual behavioural biases that lead to investment decision outcomes at the stock level. These reflect on how we build our small cap equity portfolio. But there is another decision made by our investors which can be even more important – how to select and manage fund exposures and the social influence on their behaviour.

The first concept to discuss is that of time weighted returns (these are the returns you see reported by fund managers and Morningstar reports) and money weighted returns (these are the returns underlying fund investors realise based upon when they invest in a manager or withdraw their funds).

It is a recognised fact that fund flows follow performance.

What does this mean? It means that investors are much more likely to put money into a fund after a period of recent strong outperformance (12  – 24 months). It doesn’t take much imagination to understand why this may be the case. For the fund manager, their view of the world has been justified by significant outperformance of both their peers and benchmark. They have a strong narrative to support why they are correct and why their world view is superior. For the investor, in a world of uncertainty, here presents a custodian of their wealth who has confidently navigated markets and been proven worthy of superior returns.

Statistically – which means over a much larger population of active funds over a much greater number of performance periods – this performance is likely to mean revert. Not always, but the probability does favour it. This means that the investor allocating to funds after a short period of strong performance is likely to be “buying high” in stock parlance. Human behaviour also results in most fund outflows happening after a period of underperformance, which compounds this behavioural error by “selling low”.

In studies done on money weighted returns by investors – tracking their investment dollars in and out of active funds – they lag the time weighted returns by around 1-2% per annum.

This is the Behaviour Gap.

Studies also show that as the volatility of the fund increases, the Behaviour Gap increases to as much as 5-7% per annum. In equity funds, the characteristics likely to drive greater volatility include: asset class volatility, sector focus vs diversification, and portfolio concentration (number of holdings). A 20 stock Chinese technology stock portfolio is likely to be more volatile than an MSCI World Index portfolio.

Behavioural finance traditionally explains such mistakes through individual cognitive biases, such as recency bias, loss aversion and overconfidence. René Girard’s theory of mimetic desire provides both a psychological and social mechanism for the observed behaviour. According to Girard, individuals do not form desires independently, they imitate the desires of others. Applied to markets, this means investors want the same investments other investors seem to value. What seems like irrational or undisciplined action at the individual level is, in Girard’s framework, a predictable social phenomenon. Desire, enthusiasm, fear, and capitulation propagate through networks of investors, advisers, peers, and media narratives. This is known today as FOMO (the Fear Of Missing Out). The result is often structurally poor timing of investor capital flows, producing the observed Behaviour Gap.

Mimetic desire is fueled by financial media – a business model driven by attention, not wealth accumulation and compounding returns. They need to find heroes and villains daily and the volatility of markets and manager returns provide an endless source of material. The managers who are “shooting the lights out” or “blowing up” make for great stories as they contain all the required elements: a protagonist (the manager), a conflict or struggle (their different views to the consensus), high stakes (in many cases billions of dollars of client funds) and the story arc (either ascendant or descendant). The more volatile the fund, the more likely there is a good story to be told.

A perfect example of this was the Investor Returns vs Fund Returns for the ARK Innovation ETF. After a 150%+ return in 2020, Cathie Wood became a global media icon. Investors mimetically chased the “Oracle” narrative. In late 2020 and early 2021, billions flooded in. Assets peaked at roughly $28 Billion just as the fund reached its all-time high price. Based on Morningstar analysis through to 31 May 2023, the since inception (2014) investor return of -28% per annum (money weighted return) was more than 35% per annum lower than the fund return of 9.6% per annum (time weighted return).

This is an extreme example, and before readers think this is only something applicable to retail investors in ETFs, we would note these same effects are seen across all investor groups – from the simplest individuals to the seemingly most sophisticated institutions. The common ingredient being humans making decisions.

Of course, volatility and a contrarian mindset could theoretically mean some investors are doing better than the time weighted return by buying funds low and selling them high. It just seems to be far less common and certainly not easy if an investor doesn’t deliberately block out the noise.

For investors in our corner of the world – Active Australian Small Companies – the size of the behavioural gap can be considerable. Probably close to 5-7% p.a given the volatility and concentration of most small cap funds.

What truly matters to investors are their realised returns. Net of all fees and taxes and based on their individual entry and exit prices from a fund (their individual money weighted returns). We believe funds should help investors maximise their realised returns in as many ways as possible, not only through outperforming the lower-cost benchmark over the long term, but also reducing brokerage and taxes, charging lower fees, and where possible helping to narrow the behavioural gap.

By focusing on generating returns consistently, Longwave deliberately becomes less interesting to mimetic desire and the “shoot the lights out and gather assets” business model of volatile funds. The benefit of this smoother journey for our investors is a reduction in behavioural temptation to “do something” at the wrong time.

Ultimately, realised returns are a partnership between the fund and the investor. We’ll do our part by focusing on a smoother journey and removing avoidable frictions so staying invested is easier when it matters most.

Humans are mimetically hardwired and as long as humans are social creatures, they will be pulled toward the crowd. We are not immune and it is why we have a strong investment process, aimed at controlling adverse behaviour as much as possible. The media-industrial complex fuels mimetic desire often counter to the long-term wealth interests of investors. Even with the historical wreckage in plain sight, the trap resets for every new generation and we believe it will likely continue.

Through our framework, we see many many traps laid out for unsuspecting investors as we enter 2026. For the next generation, who enter the world after a schooling almost defined by memes and the need to socially fit in, the ability to think independently, form contrarian views and spot bad actors preying on default human behaviours is an uncommon but worthwhile skill.