Political Cognitive Biases Effects on Fund Managers’ Performance

Marian Moszoro is a visiting scholar at University of California Berkeley Haas School of Business. This post is based on a recent paper by Professor Moszoro and Michael Bykhovsky of the Center for Open Economics.

Who does a better job in managing money—Democrats or Republicans? We finally have at least a partial answer.

Ideology is an important bias in the financial industry which is not usually factored in. Under rational agent hypothesis, financial industry practitioners should not be affected by political discourse. Rare events, however, may silence rationality and potentiate cognitive dissonance on a spectrum of agents.

We assembled a comprehensive dataset of equity hedge fund managers’ performance and political affiliation matched by their individual partisan contributions. We find that for the years 2004-2014 Democratic and Republican equity hedge fund managers did about the same (which should give pause to those who thinks that partisan connections show up in better performance or either political party has a superior understanding of the economy), but document higher returns of equity hedge funds managed by Democrats for 10 subsequent months—from December 2008 to September 2009. The difference in performance is robust to several regression specifications, placebo time windows, and randomly shuffled partisan affiliation. Given the $380 billion dollars in equity hedge funds’ assets under management in 2009, the estimated 72 basis points difference in monthly performance between Democratic and Republican managers accrued $13.7 billion in relative losses for investors in funds managed by the later.

We argue that the divergence in political parties’ interpretation of central bank policy following Obama’s election sparked a difference in decision-making under cognitive dissonance. Rationally, both Democratic and Republican managers were equally aware of the political need to offer differing interpretations by the parties, and both should have ignored them. While all equity hedge fund managers were exposed to the same data, managers’ investment decisions were affected by the framing dominant in their politically affine circles. The argument that the managers have intrinsically differing risk preferences is not supported in other uncertain times: When there was no such interpretation divergence, their fund performance was roughly similar.

We showed that partisan affiliation is an important bias in the financial industry, which was not considered during the financial crisis and recovery. The difference in performance by hedge fund managers is an indication of the extent to which ideology can affect the processing of information and whose effects become salient during abnormal situations.

The complete paper is available for download here.

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