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Ordeal & risk

Childhood trauma from a parent’s death or divorce causes mutual fund managers to be more risk averse later in life, finds a new study co-authored by Professor Raghu Rau of Cambridge Judge Business School.

Scissors dividing a paper garland family.
Raghavendra Rau
Professor Raghavendra Rau

Finance professionals may focus laser-like on the latest numbers, but traumatic childhood events can in fact affect their investment decisions decades later, finds a new study co-authored at Cambridge Judge Business School.

The study – “Till death (or divorce) do us part” – focuses on mutual fund managers who experienced family disruption during their childhood years. It concludes that such childhood trauma causes fund managers to be more risk averse and to invest less in “lottery-like” stocks, make smaller tracking errors (the gap between a fund’s return and a tracked benchmark index), and bet less during recessions on “factors” (such as momentum as measured by past performance, and size as measured by market capitalisation).

Yet when the study looked at performance, it found that such fund managers do not perform better or worse than peers who did not experience such childhood events. This suggests that managers so affected during childhood tend to avoid both upside and downside risks, as they “forgo upside potential in order to avoid downside potential.”

This also shows up in their behaviour after they have been appointed to manage funds. Affected fund managers are more likely to avoid holding stocks of firms in their portfolios that take risks. For example, they are significantly more likely to sell their positions (or even terminate their holdings) in stocks of firms that experience CEO turnover or announce a merger, particularly if the target in the announced acquisition is a foreign or non-public firm. Affected managers are also more likely to sell their stock if the VIX index (market volatility index, sometimes called the “fear” index) goes up.

The study focuses on mutual fund managers for US-based funds between 1980 and 2017, using a final sample of more than 500 fund managers and 5,241 fund years – based on information including federal and state records, obituaries, college yearbooks and city directories.

“It is commonly believed that fund managers with their extensive experience and training are unlikely to be affected by behavioural factors, but our evidence suggests otherwise,” said study co-author Raghavendra Rau, Sir Evelyn de Rothschild Professor of Finance at Cambridge Judge Business School. “And the phenomenon we examine, family disruption, is becoming increasingly prevalent across societies around the world. About 40 per cent of children in the US experience a parent’s divorce before they reach adulthood, and more than half of all divorces involve children under age 18.”

The study finds that fund managers affected by a parent’s death or divorce before the age of 20 reduce total fund risk by about 17 per cent (relative to a sample mean) after they take office.

This is most pronounced during their most formative years (age 5-15) compared to less-formative years (0-4 or 16-19), among fund managers whose widowed parents did not quickly acquire new partners, and in situations where there was not social support including membership religion-based networks. Age, geography and economic backgrounds do not change the underlying results.

“The reduction in total risk results from managers taking less idiosyncratic, systematic, and downside risk,” the study says. “The evidence suggests that fund managers who experienced early-life family disruption differ significantly in terms of several portfolio activities.”

Professor Rau previously studied the affect of other types of early-life trauma – proximity to earthquakes, floods and other natural disaster – on behaviour of CEOs much later in life. Whereas that earlier CEO study was based on whether the person lived in the area of the disaster (whether witnessed or not), the new fund manager study is based on individual experience of having a parent die or divorce during childhood.

“The effect on people’s brains of such childhood experiences has long been reflected in medical literature, but we wanted to test it on how it affects finance professionals later in life,” said Professor Rau. “While the study focuses on mutual fund managers, we believe that the findings related to risk-taking behaviour would also apply to other investment professionals.”

The study – entitled “Till death (or divorce) do us part: early-life family disruption and fund manager behaviour” – is co-authored by André Betzer of BUW-Schumpeter School of Business and Economics, Peter Limbach of University of Cologne, Raghavendra Rau of Cambridge Judge Business School, and Henrik Schürmann of BUW-Schumpeter School of Business and Economics.