Should investors care about a fund manager’s relationship status? What kind of car they drive? Ask them if they’ve won any poker games lately?
Research points to yes.
A recent outpouring of academic papers links the investment performance of professional fund managers to their characteristics as individuals — how they grew up, their personality traits, even their testosterone levels. Studies have explored the impact of everything from where investors went to school to whether they lost a parent in childhood.
The studies have attracted widespread attention from financial and mainstream media outlets — Institutional Investor included. You’ve probably seen the headlines: “A Hedge Fund Manager Who Drives a Ferrari Will Probably Underperform.” “‘Psychopath’ Hedge Fund Managers Make Less Money Than Nice Guys.” “Why ‘Alpha Males’ Make Bad Hedge Fund Managers.” The listgoeson.
Sugata Ray, a University of Alabama business school professor, and his regular co-author Yan Lu have been behind many of these studies. Ray attributes their work’s popularity to relatability. “Not everyone’s a finance professional, but everyone’s a human being,” he says. “Not everyone can understand a complicated derivative, but everyone can understand wanting to drive a fancy car.”
The universality of the research being produced by Ray and others makes for interesting journalism — or clickbait, for those feeling less generous. But it’s not yet clear what impact, if any, the emerging research will have on the investment industry.
Actual investment professionals might email around a link to an article claiming that hedge fund managers who drive minivans deliver the best risk-adjusted returns. But will allocators actually make manager selection decisions based on what cars are parked out front?
More importantly, is there a world in which institutional investors consider it fair game to ask portfolio managers about all the intimate details of their personal lives — and then factor in that information in deciding whether to hire them?
There was a time not so long ago when the prevailing opinion in corporate financial literature was that a manager’s personal traits had no bearing on his or her company’s performance.
“The idea was that if the market is perfectly competitive, there is only one way to manage a firm and stay in business,” says Raghavendra Rau, a finance professor at the University of Cambridge. “The personal characteristics of managers didn’t matter: If you were the CEO of a company and you were replaced by a different person, it wouldn’t matter because that new person wouldn’t have any leeway to manage the firm any differently.” The same logic applied to fund managers, who had to deliver the best possible returns “or else somebody would drive you out of business.”
By the mid-2000s, however, this theory had been thoroughly debunked. Academics amassed a body of research proving conclusively that markets weren’t perfectly competitive — and that personal characteristics did, in fact, influence professional outcomes. According to Rau, studies examining “exactly what those personal characteristics are and how they impact fund manager behavior has really exploded” — spreading beyond finance into fields like psychology.
One such paper arose after a hedge fund of funds sought to quantify the relationship between personality traits and performance. The firm, San Francisco-based TeamCo Advisers, approached psychology professor Dacher Keltner and psychology PhD Leanne ten Brinke, now an assistant professor at the University of Denver.
Ten Brinke remembers having “no idea what a hedge fund was.” Her prior research had focused on the psychopathic tendencies of criminals. At that time, she was conducting personality assessments and using nonverbal cues to identify psychopathic and other personality traits. TeamCo Advisers wanted to take that skill set and apply it to hedge fund manager selection. “They were interested in if you could find a personality trait that led to greater returns,” says ten Brinke. “But they were particularly interested in avoiding blowups — Bernie Madoff types who are just ripping people off.”
The resulting collaboration was a study focused on what psychologists refer to as the dark triad: narcissism, Machiavellianism, and psychopathy. By analyzing videotaped interviews of 101 hedge fund managers, ten Brinke and Keltner spotted these traits and examined whether there was any distinguishable link to investment performance.
The results were definitive: Hedge fund managers who most exhibited the dark triad characteristics trailed the overall group by almost a full percentage point each year in investment returns annualized from 2005 to 2015. When their performance was adjusted for risk, the gap grew even wider.
It was exactly the sort of data point TeamCo had been looking for — but the fund-of-funds firm wouldn’t get much use out of it. The month before the findings were published online in the Personality and Social Psychology Bulletin, TeamCo founder David Perry announced his plan to wind down his firm’s operations by early 2018. He blamed the firm’s closing on the “brutally challenging” market for hedge funds following the financial crisis, telling Reuters that investors “don’t want to pay those fees for returns that are nowhere near as good as they expected.”
Three and a half weeks later, ten Brinke, Keltner, and TeamCo’s director of hedge fund research, Aimee Kish, published their paper on the study: “Hedge Fund Managers With Psychopathic Tendencies Make for Worse Investors.” It instantly went viral, prompting coverage in Bloomberg and Psychology Today, as well as in mainstream news outlets like CNN and the BBC.
One of the many investors who reached out to ten Brinke about the potential for practical applications was Christopher Schelling, private equity director for the Texas Municipal Retirement System. The $29 billion pension fund was working on ways to mitigate some of the human biases that influence manager selection. Schelling found the research compelling — so much so that he shared the findings in a September 2018 column.
But when Schelling and his colleagues at Texas Municipal considered the actual implementation — literally asking potential managers to take a psychopath test — they decided it was “maybe not the best way to start a partnership.”
Instead, Schelling says, the pension fund uses a more general personality assessment. The online test, which takes about 45 minutes to complete and was developed by Profiles International, scores individuals in areas like decisiveness and sociability by posing questions like, “Do you prefer to work in a group or on your own?”
“It’s relatively easy to complete,” says Schelling, who, like his colleagues, took the test himself. The assessment is now used to evaluate all of the fund’s potential private market investors, including in private equity, real estate, and real assets. “We’ve tried it with hedge funds, but there’s been a lot less willingness,” Schelling adds.
There has been at least one clear instance when the test helped Texas Municipal identify a red flag, although the long-term impacts aren’t yet clear. Schelling recalls a prospective manager whose personality assessment results made it apparent that they had tried to “game the system.”
“If someone’s just trying to make themselves look highly favorable, there’s going to be inconsistent results — and the test will score that,” he explains. “In this particular case, there were already some concerns on our end about this manager. Seeing that they were gaming the test made it clear that this is definitely someone we don’t want to work with.”
Schelling says he isn’t aware of any other asset owners that are using personality testing, though he’s come across “one or two really small funds of funds that were doing something similar,” as well as a multistrategy hedge fund that used behavioral profiling on its portfolio managers.
But as manager selection becomes more sophisticated — and important, given wide performance dispersions between top- and bottom-quartile managers — the private equity director expects to see personality testing and similar tools flourish. “Ultimately,” Schelling says, “the Holy Grail would be to find some characteristics that we can measure in due diligence that are predictive of better returns.”
In the search for this Holy Grail, investor Brian Altenburg says his firm, Highmore, has identified more than 20 behavioral factors that help it make better decisions.
“When you’re investing in something, be it a stock or a company or a real estate holding, you’re really investing in the people,” Altenburg says. The former Oppenheimer & Co. executive, who studied behavioral finance as a PhD candidate at Oxford University, has been responsible for developing Highmore’s proprietary behavioral assessments. These test for qualities like extroversion and introversion, as well as how people behave under stress. According to Altenburg, the assessments are used not just to source investments but also to better serve the firm’s clients.
“When you onboard a client, you go through a process of trying to understand their risk parameters,” he says. “We thought, ‘Could you apply a behavioral screen to clients to better understand what they want?’”
As personal data becomes increasingly accessible online, the Highmore co-founder suggests that gleaning behavioral insights just based on publicly available information will be possible — no personality testing required. In fact, many of the academic researchers interviewed for this story have pointed to the increase in data as one of the main drivers behind the rapid growth in behavioral research.
But this rise in data has been accompanied by concerns over privacy. Some governments have, in response, imposed rules like the U.K.’s sweeping General Data Protection Regulation. “Data availability has increased very rapidly, but there’s also a number of data privacy acts being passed,” Cambridge professor Rau says. “So it’s a question as to which one will dominate.”
The possibly thorny implications of firms using personal data for profit is one reason why Andrei Simonov, a finance professor at Michigan State University’s business school, is skeptical that behavioral finance research will ever find practical application on a large scale.
“You start bumping into privacy concerns,” Simonov says. “I don’t think there is going to be lots of this kind of thing.”
Beyond these privacy issues, there’s also the risk that taking personal data into account would introduce new biases, rather than mitigating them. An asset management firm seeking to hire portfolio managers who possess a certain trait could end up with a group of investors with similar backgrounds and upbringings, as opposed to a diverse team — which research links to more positive outcomes.
Quantopian, a quantitative investment firm that seeds crowdsourced investment ideas, does not use behavioral profiling for this very reason. “We try to avoid all that,” says founder John Fawcett. When considering which strategies to seed, Fawcett says Quantopian separates out all information about the person who developed an investment algorithm and just evaluates the algorithm itself.
“If it’s human allocators looking at human managers,” he says, “all the biases creep in.”
Even the researchers behind some behavioral studies admit that at least some of their research may never go beyond the lab.
Rau is the first to admit that it would be challenging, or at least uncomfortable, for investment firms to make use of a paper he published with three co-authors: “Till Death (or Divorce) Do Us Part: Early-Life Family Disruption and Fund Manager Behavior.” The study examined how mutual fund managers were affected by the death or divorce of a parent — a subject not commonly brought up in portfolio manager interviews.
“It’s very difficult to ask people these kinds of questions,” he says. “It might be useful information — but tough to actually ask people about.”
But regardless of whether they ultimately use the studies being published by Rau and his peers, professional investors follow them. Ray and Lu get emails and calls from interested investors every time they publish a new paper, and other academics interviewed say the same.
At Texas Municipal, Schelling says that he and his colleagues “consume a ton of academic research — not just about psychology or personality profiles but all sorts of characteristics.” A particular paper might not inform how the fund interprets the results of manager personality assessments, but it could still be factored into the due diligence process in some other way — even a paper on a subject like car ownership.
“It may seem silly,” he says. “But in my experience, yes, if there’s a lot of red Ferraris in the parking lot — particularly if they’re leaving by 3 in the afternoon — it’s time to get off the bus.”