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Hedge Fund Manager Personal Risk Taking vs. Investment Performance

| | Posted in: Animal Spirits, Mutual/Hedge Funds

Do hedge fund managers who seek excitement as indicated by choice of cars invest differently from those who do not? In their December 2016 paper entitled “Sensation Seeking, Sports Cars, and Hedge Funds”, Yan Lu, Sugata Ray and Melvyn Teo investigate the relationship between hedge fund manager personal car selection (body style, maximum horsepower, maximum torque, passenger volume and safety ratings) and fund performance. After identifying a large set of hedge fund managers, they match managers to cars and car characteristics via VIN Place, Autocheck, cars.com, cars-data and the Insurance Institute for Highway Safety, categorizing cars as sports cars, minivans or other based on body style. They then relate hedge fund manager car data as available to subsequent performance and characteristics of associated hedge funds. Using car data and monthly net-of-fee returns, assets under management and other fund characteristics for 1,774 vehicles (including 163 sports cars and 101 minivans) purchased by 1,144 hedge fund managers during January 1994 through December 2015, they find that:

  • Hedge fund managers who own powerful/sports cars (unexciting/practical cars) take more (less) investment risk. Specifically, based on annual fund volatility:
    • Sports car owner funds are on average 1.8 percentage points more volatile than non-sports car owner funds.
    • Funds of managers owning cars with high horsepower (torque) are on average 1.1 (1.2) percentage points more volatile than those of managers owning cars with low horsepower (torque).
    • Minivan owner funds are on average 1.3 percentage points less volatile than non-minivan owners.
    • Funds of managers owning cars with high passenger volumes (excellent safety ratings) are on average 1.6 (1.0) percentage points less volatile than those of managers owning cars with with low passenger volumes (poor safety ratings).
    • Results remain statistically and economically significant after controlling for many other factors that may affect fund performance.
  • Fund managers who own performance cars do not generate higher average returns than those who do not, and therefore deliver lower Sharpe ratios. For example:
    • A one standard deviation increase in vehicle maximum horsepower relates to a 0.18 decrease in annualized fund Sharpe ratio (a 21% reduction relative to the sample average).
    • A one standard deviation increase in vehicle passenger volume relates to a 0.18 increase in annualized fund Sharpe ratio.
  • Performance car owners have higher portfolio turnovers and are more likely to terminate funds, engage in fraudulent behavior, hold non-index stocks and fail to exploit well-known systematic factors.

In summary, evidence indicates that the kind of car owned by a hedge fund manager carries over to the fund’s volatility but not average return, such that performance car ownership predicts relatively low fund Sharpe ratio.

Investors should perhaps think about what car(s) they own.

Cautions regarding findings include:

  • The authors are able to assign car ownership to only a modest fraction of hedge fund managers.
  • Findings suggest that risk-seeking hedge fund managers may offer higher diversification potential than risk-avoiding managers.
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