back to news & insights


Nov 17, 2015

Price Gouging, Cancer Screenings and an Investing Tip

Samantha McLemore

This interesting Washington Post article recounts the history of how the American Cancer Society (ACS) ignored the evidence on the value of mammograms for younger women for many years before finally changing their recommendation last month. The history fascinates me on many fronts relative to investing.

People currently abhor Turing Pharmaceuticals where the CEO (a notorious hedge fund manager) acquired a toxoplasmosis drug and jacked the price up 5,000%. This type of price gouging without any incremental value-add certainly isn’t ethical and makes me want to cringe. According to the company, it had programs to ensure everyone who needed treatment received it. Given the number of hospitalizations per year from toxoplasmosis, the incremental annual cost to the system approximates $3.2M. This is insignificant to a country that is projected to spend $3.2T on healthcare expenditures this year. Yet Hilary Clinton’s made it into a major issue in her campaign. Of course, this behavior writ large can have costly consequences.

On the other hand, I haven’t heard anyone decry the travesty of the American Cancer Society clinging to their position too long despite clear evidence to the contrary. Some simple math on the number of mammograms recommended previously versus now at an average cost of $243 per scan shows that the potential system wide cost savings would be about $7.5B annually or ~2,300 times the impact of Turing’s price hike. Why isn’t anyone upset about this? As we know well, people aren’t entirely (or even moderately) rational.

The entire saga illustrates many interesting behavioral finance concepts. First, the ACS drama exhibits clear belief perseverance, which is when people hold opinions too tightly and for too long. Prominent cancer researchers questioned the value of mammograms nearly four decades ago. The ACS held its position even as other groups charged with preventing disease, like the U.S Preventative Services Task Force, discouraged screening. People dismiss evidence that doesn’t support their beliefs and look for evidence to support their case (confirmation bias). This happens all the time in investing.

Additionally, people prefer stories to data. People remember narratives far better than numbers and facts. The ACS fully believed that early detection helped save lives. This was their mission. When data and evidence didn’t support this view, the information could not be assimilated into their minds – classic cognitive dissonance. The people were not stupid or incompetent; they just could not accept the facts. They were human and subject to the same tendencies we all are. One of Bill’s great lines is that, “people are impervious to facts.” When I was a young analyst, I thought he was being cheeky, but in fact he was just making an empirical observation on behavior.

I recently attended a session where Daniel Kahneman, the great psychologist who won the Nobel Prize for behavioral economics, spoke. He recounted a story of a team he led as a young man. They were endeavoring to write a text book, which they aimed to complete in the next couple years. When he asked an advisor, who had guided many such teams, how often the others were successful and how long it took them, the advisor said the majority failed outright and the successful ones took 8 years to publish anything on average. Kahneman chuckled about how a rational response would have been to quit right there, yet his team held to their belief they would perform better and kept working. No one is above our deeply embedded behavioral tendencies.

Education and awareness can help us be better though. We constantly try to educate ourselves on behavioral tendencies (I’m attending a Harvard conference on the topic in a couple weeks) and ask ourselves where they manifest in our process. Here’s an example. Amazon is both the single biggest contributor to performance over the life of the strategy and the single largest position now. A common behavioral tendency is for people to sell their winners and keep their losers. We would have done better if we’d never sold a share. We typically monetize volatility by paring back winners and adding to losers. In this case, we haven’t more aggressively cut back our Amazon options exposure after such a massive run this year because we know that historically and behaviorally, the inclination is to cut back too much rather than too little.

As a thought experiment, where are other possible areas that the actual data and facts are subject to belief perseverance? Here are some of our ideas.

    • Investors in energy. The great global cyclical boom is over and valuations haven’t fully adjusted to the new reality.

    • The Fed on rate hikes. Inflation is benign; the economy is nowhere near overheating. Rate hikes are riskier than believed.

    • Airline valuations. Stock prices still don’t fully reflect improved fundamentals.

    • Selecting investment managers. Investors love managers with great historical performance when evidence actually suggests that buying managers with good long-term performance during a period of short-term underperformance yields better results.

    • SEC ignoring detrimental market changes. High frequency-trading, removal of the uptick rule, algorithmic trading and the lack of market makers, prop desks, etc willing to take the other side of trades are destabilizing the market and increasing volatility.

    • Massive flows into bond funds. This behavior suggests people are not owning up to the risks of rising rates on the returns of such products.

The views expressed in this report reflect those of the LMM LLC (LMM) strategy’s portfolio manager(s) as of the date of the report. Any views are subject to change at any time based on market or other conditions, and LMM disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results. It shall not be assumed that other strategy investments will be profitable or will equal the performance of the securities mentioned.

©2015 LMM LLC. LMM LLC is owned by Bill Miller and Legg Mason, Inc.