Research shows that traumatic childhood experiences can shape people for the rest of their lives — including how they behave as professional investors.
A new study examines how early-life family disruption — specifically, the death or divorce of a parent — affects the professional investment decisions of mutual fund managers. It finds that fund managers who experienced loss or divorce at a young age were significantly more risk-averse as investors, taking about 17 percent less risk in the funds they manage.
“There is a lot of medical literature that says that there is a part of your brain that is affected when you experience trauma growing up,” said Raghavendra Rau, a finance professor at the University of Cambridge who has previously researched the impact of early-life trauma on CEO behavior.
For the new study into fund manager behavior, Rau partnered with lead author André Betzer of the University of Wuppertal in Germany, finance professor Peter Limbach of the University of Cologne in Germany, and University of Wuppertal PhD student Henrik Schürmann.
“We had the intuition that when your parents die or divorce that this affects you later in life,” said Limbach, referencing his own childhood experience with divorce. “The main takeaway is that even finance professionals who have training, experience, and a professional background can be affected by shocks that occur early in life.”
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The study — entitled “Till Death (Or Divorce) Do Us Part: Early-Life Family Disruption and Fund Manager Behavior” — was based on a sample of over 500 mutual fund managers who ran U.S. active equity funds between 1980 and 2017, with details of their family histories derived from U.S. census data and parent obituaries.
Funds managed by investors who experienced parental death or divorce made up about 15 percent of the sample. The authors found that these funds invested in fewer “lottery” stocks, exhibited less tracking error, and had lower fund turnover. According to the study, this risk aversion resulted in risk-adjusted returns that were roughly equivalent to those of fund managers who took on more total fund risk.
“You have investors who are willing to pay in terms of upside potential to avoid downside potential,” Limbach said by phone. “What basically seems to be happening is they stay close to the benchmark, which limits the opportunity for positive or negative alpha.”
The death of a parent was shown to have a greater impact on a fund manager’s risk tolerance compared to divorce, while family disruption occurring during a manager’s younger years had more impact compared to events that took place in their later teenaged years.
The results persisted even when the authors accounted for other variables such as managers’ ages, economic backgrounds, and hometowns.
Although the study focused solely on mutual fund managers, Rau said that he would expect to find similar results among other groups of professional investors, such as hedge fund managers.
“Human biases and personal characteristics have been shown to affect choices which have real consequences in financial world,” Rau said. “That’s the really interesting, big-picture idea.”