'Tell me about your childhood' may become required RFP question
Cambridge Judge Business School has highligthted research suggesting that fund selectors may need to ask probing questions about the childhoods of portfolio managers in order to properly assess their attitude to risk, particularly around stock picking as active managers.
The study - Till Death (or Divorce) Do Us Part: Early-Life Family Disruption and Fund Manager Behaviour , co-authored by André Betzer, BUW- Schumpeter School of Business and Economics, Peter Limbach, University of Cologne and Centre for Financial Research (CFR), professor Raghavendra Rau University of Cambridge, and Henrik Schürmann BUW - Schumpeter School of Business and Economics - has looked at the experiences of managers who experienced the death or divorce of a parent in their early years, and has concluded that such family disruptions cause managers to be more risk averse and invest less in "lottery-like" stocks - effectively establishing a link between trauma and attitude to risk decades later.
Additionally the research suggests that such managers make smaller tracking errors and bet less during recessions on factors such as momentum and size.
However, it also found that overall performance of such managers was not better or worse thatn peers that did not experience childhood trauma. The co-authors conclude that this points to the affected managers avoiding both updside and downside risks - avoiding upside potential to avoid downside potential.
"This also shows up in their behaviour after they have been appointed to manage funds," a note on the resarch published on the website of Cambridgte Judge Business Schools states.
"Affected fund managers are more likely to avoid holding stocks of firms in their portfolios that take risks. For example, they are significantly more likely to sell their positions (or even terminate their holdings) in stocks of firms that experience CEO turnover or announce a merger, particularly if the target in the announced acquisition is a foreign or non-public firm. Affected managers are also more likely to sell their stock if the VIX index goes up."
What is not known is whether there is any particular cultural element to the biases uncovered. The study focused on mutual fund managers for US based funds between 1980-2017, based on information including "federal and state records, obituaries, college yearbooks and city directories".
The sample size was more than 500 fund managers representing some 5,241 "fund years."
Co-author Rau said: "It is commonly believed that fund managers with their extensive experience and training are unlikely to be affected by behavioural factors, but our evidence suggests otherwise. And the phenomenon we examine, family disruption, is becoming increasingly prevalent across societies around the world. About 40% of children in the US experience a parent's divorce before they reach adulthood, and more than half of all divorces involve children under age 18."
The study concludes that "fund managers affected by a parent's death or divorce before the age of 20 reduce total fund risk by about 17% (relative to a sample mean) after they take office."
"This is most pronounced during their most formative years (age 5-15) compared to less-formative years (0-4 or 16-19), among fund managers whose widowed parents did not quickly acquire new partners, and in situations where there was not social support including membership religion-based networks. Age, geography and economic backgrounds do not change the underlying results."
"The reduction in total risk results from managers taking less idiosyncratic, systematic, and downside risk. The evidence suggests that fund managers who experienced early-life family disruption differ significantly in terms of several portfolio activities."
Rau added: "The effect on people's brains of such childhood experiences has long been reflected in medical literature, but we wanted to test it on how it affects finance professionals later in life. While the study focuses on mutual fund managers, we believe that the findings related to risk-taking behaviour would also apply to other investment professionals."
