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A Different Take on Facebook

Mohamed El-Erian |CO-CIO, PIMCO
Monday, 21 May 2012 | 12:50 PM ET

Behavioral finance specialists will have a field day with the Facebook IPOas it speaks volumes to an issue that differentiates them from those that espouse the efficient market hypothesis.- namely, that investors can be vulnerable to mistakes dictated by unconscious biases.

Source: CNBC

Or, put another way, the manner that our brains have evolved and work may not always result in the best investment decisions.

And the implications could go beyond this.

Facebook was one of the most hyped IPOs in history, and understandably so. The company has over 900 million users around the world, is a leader and a major disrupter and, as such, continues to redefine not only social networking but also a growing number of people's interactions with the internet and with their mobile tools.

In response, the underwriters set the IPO price at the top end of a range that, already, had been specified above initial market expectations. They also increased the number of shares offered to the public, and they reserved a well-publicized allocation for retail investors.

All this could well have amplified the risks of a mistake which investors can make—namely, to overpay for a very familiar and hyped name. Indeed, the behavioral finance literature cautions investors against falling into the trap of letting familiarity trump risk-adjusted valuations.

In the event, after the initial pop on the delay opening on Friday, Facebook sold off and closed just above the initial pricing of $38.

Moreover, media sources reported that the support of underwriters was needed to maintain the market price above this psychological level. They succeeded on Friday only to see the stock trade down dramatically this morning.

While it is still very early days, the initial post-IPO market action suggests that behavioralists may well have a new case study to analyze.

And this Facebook episode could also serve as a timely reminder for investors to consider not only what they invest in, but also how they invest— especially in hyped names.

These are not the only takeaways.

Several pundits had observed that the Facebook hype could act as a catalyst for the return to the equity markets of retail investors who remain on the sidelines.

What occurred in the last two days of trading, along with the NASDAQ's technical difficulties on Friday, suggest that we may need to wait for another, more legitimate catalyst.

Mohamed El-Erian is the CEO and Co-CIO of PIMCO, which oversees nearly $1.8 trillion in assets and runs the Pimco Total Return Fund, the largest bond fund in the world. His book, "When Markets Collide," was a New York Times and Wall Street Journal bestseller, won the Financial Times/Goldman Sachs 2008 Business Book of the Year and was named a book of the year by The Economist and one of the best business books of all time by the Independent (UK).

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