"... even professional hedge fund managers are letting their political or psychological biases get in the way of their investments."

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Are your political opinions costing you money?
Liberals and conservatives alike let biases skew their investing
By Brett Arends, December 29, 2014

A while ago, when I was attending a concert at Bard College in central New York, I got talking with an elderly man who wanted to bend my ear about government spending and “runaway inflation.” He grew incredulous when I pointed out that there wasn’t any runaway inflation. It was either being hidden, or was just about to hit, he said. I think he was holding a lot of his money in gold in anticipation.

He was not alone. There is a whole army of people who have been convinced that we are about to turn into Weimar Germany.

I cannot possibly fault people for fearing, five or so years ago, that government policies might lead to inflation. I’ll freely confess I was worried about it myself. The real problem is sticking with an opinion long after the world has proved it misplaced. “I change my mind when the facts change,” John Maynard Keynes is supposed to have retorted once in an argument, adding: “What do you do, sir?” If the man I was talking to then has gone all-in on his gold bullion opinion, he’s lost about half his money, and missed out on a boom on Wall Street.

It’s another example of the dangers of letting personal opinions, including your political opinions, get in the way of your investments. A lot of people have lost a lot of money over the past six or so years for precisely that reason.

And so comes a fascinating research paper by two finance professors at the University of Arizona, Luke Asher DeVault and Richard Sias, entitled “Hedge Fund Politics and Portfolios.”

They have looked at nearly 500 hedge funds during the period from 2000 through 2012, and compared their political donations and their investment strategies. In so doing they tried to answer some important questions. Do politically “conservative” funds invest differently from “liberal” funds? If so, how — and why?

Politics and portfolios
It must have been exhausting work. They’ve looked at 13(f) regulatory filings for funds. They compared the funds’ stock investments based on various characteristics, such as profitability, company maturity, stability and so on. Then they trawled the Federal Election Commission databases for contributions. I don’t usually talk about methodology, but anyone willing to go blind doing this while the rest of us were watching “Breaking Bad” or “Game of Thrones” deserves recognition.

What they found? In a nutshell, most hedge funds are either “strongly conservative” or “strongly liberal” in their campaign donations (conservative funds outnumber liberal ones, but not by much). And there was a statistically meaningful difference in how they invested.

In a nutshell: Funds run by liberals were much more likely to invest in smaller companies, riskier companies, younger companies and more speculative companies. Funds run by conservatives were more likely to invest in larger, more stable and “value”-oriented companies.

Furthermore, funds run by liberals were more likely to make big, sweeping changes to their portfolios. Conservatives tended to be more cautious.

Now it’s true that some of these differences might be nakedly political. Conservatives, especially during the George W. Bush administration, were probably more willing to invest in Big Oil, and Big Tobacco, and so on. Liberals were probably more willing to invest in young alternative startups run by kids. But DeVault and Sias argue the real differences are more fundamental.

There is an enormous body of research into the connections between psychological traits and political persuasion. There’s even research into whether these differences are due to nature or nurture (the research is based on things like comparing identical and fraternal twins, adoptees and so on). DeVault and Sias argue that people who are more comfortable with ambiguity and change tend to be more liberal; such people are also more likely to invest in speculative small caps. Meanwhile people who want “order” and “stability” are likely to feel reassured by blue- chip value stocks and, say, former Vice President Dick Cheney.

Make of it what you will.

But arguably the most important news from this research is that even professional hedge fund managers are letting their political or psychological biases get in the way of their investments. It’s yet another reason so many of them underperform.

There is an investment cult which tells you that you should only ever hold passively managed “index” funds because absolutely nobody can beat the stock market consistently. The market, say members of this cult, is just too smart to beat.

Phooey.

But there is a parallel argument in favor of index funds which is a lot better. It’s that even though markets can be beaten, most people end up letting their emotions get in the way of good investment decisions. They are too afraid of uncertainty, or not afraid enough; they are too worried that the Democrat (or Republican) in the White House is sending the country to ruin; and so on. If even professional hedge fund managers are letting their biases color their portfolio, are you sure that you aren’t?
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