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Thrill-Seeking and Investment Strategy: Hedge Fund Managers Reflect Their Cars

Thrill-Seeking and Investment Strategy: Hedge Fund Managers Reflect Their Cars

By: Larry Swedroe

Sensation-seeking is a personality trait that can be described as the seeking of varied, novel, complex and intense sensations and experiences, and the willingness to take physical, social, legal and financial risks for the sake of such experiences. Does sensation-seeking affect the behavior of financial market participants, such as professional fund managers?

That’s exactly the question that Stephen Brown, Yan Lu, Sugata Ray and Melvyn Teo, the authors of the December 2016 paper “Sensation Seeking, Sports Cars, and Hedge Funds,” attempt to answer.

The field of behavioral finance has provided us with some important insights on the subject. For example, the research has found that individuals prefer stocks with low nominal prices, high volatility (and high beta) and high positive skewness (in which returns to the right of, or more than, the mean are fewer, but further from it, then returns to the left of, or less than, the mean, like a lottery ticket). In other words, they have a preference for gambling. Research has also found that investors with gambling preferences trade actively.

What A ‘Sensational’ Car Suggests

Brown, Lu, Ray and Teo contribute to the literature by examining professional hedge fund investors. Their study used data on hedge fund managers’ automobile ownership to gauge their proclivity for sensation-seeking and then analyzed the impact on behavior and performance. The authors examined the characteristics of vehicles the managers purchased, such as body style, maximum horsepower, maximum torque, passenger volume and safety ratings.

Their working hypothesis was that “the purchase of a powerful sports car, more often than not, conveys the intent to drive in a spirited fashion and therefore signals an inclination for sensation seeking. Conversely … the acquisition of a practical but unexciting minivan reflects an aversion to sensation seeking.”

The study covered the period 994 through 2012 and nearly 50,000 hedge funds. To quote the authors, “the empirical results are striking.” Specifically:

  • Hedge fund managers who purchase performance cars take on more investment risk than fund managers who eschew performance cars.
  • Sports car drivers deliver returns that are 1.80 percentage points per annum more volatile than nonsports-car drivers, a 16.6% increase in volatility over that of drivers who shun sports cars. Similarly, drivers of high-horsepower and high-torque automobiles exhibit 1.14 percentage points and 1.25 percentage points per annum more volatility, respectively, in the funds that they manage than drivers of low-horsepower and low-torque automobiles.
  • Managers who acquire practical but unexciting cars take on lower investment risk relative to managers who shun such cars. For instance, minivan owners generate returns 1.28 percentage points per annum less volatile than other owners, an 11.74% reduction in risk relative to managers who eschew minivans.
  • Managers who purchase cars with high passenger volumes and excellent safety ratings also deliver returns that are, on an annualized basis, 1.59 percentage points and 0.97 percentage points less volatile, respectively, than managers who purchase cars with low passenger volumes and poor safety ratings.
  • Sensation-seeking hedge fund managers trade more frequently (hurting performance, and suggesting overconfidence), have higher active shares (are less diversified, again suggesting overconfidence) and engage in more unconventional strategies. The opposite holds true for owners of cars with anti-sensation attributes.
  • These results were both economically and statistically significant, and were robust to various controls (such as age, marital status and age of the fund).

Sensation-Seeking Signals Underperformance

Unfortunately, the results also showed that, despite taking more investment risk, fund managers who purchase performance cars do not generate greater returns than fund managers who eschew those cars.

The authors write: “Buyers of cars with pro-sensation attributes deliver lower Sharpe ratios than do buyers of cars with anti-sensation attributes. For example, a one standard deviation increase in vehicle maximum horsepower is associated with a decrease in fund annualized Sharpe ratio of 0.18. This represents a 21.43% reduction relative to the Sharpe ratio of the average fund in our sample. In contrast, a one standard deviation increase in vehicle passenger volume is associated with a 0.18 increase in fund annualized Sharpe ratio.”

Brown, Lu, Ray and Teo also found that “the sensation seeking story further predicts that the incremental risk taking by sensation seekers extends beyond financial markets.” They found “that managers who acquire cars with pro-sensation attributes exhibit heightened operational risk while managers who acquire cars with anti-sensation attributes exhibit lower operational risk.

Operational Risk

Specifically, controlling for a variety of factors that may affect fund behavior, performance car drivers are more likely to terminate their funds and report regulatory, civil, and criminal violations on their Form ADVs. Conversely, drivers of practical but unexciting cars are less likely to shut down their funds and report violations on their Form ADVs.” Clearly, “innate personality traits such as sensation seeking can engender operational risk.”

The authors concluded: “Empirical results broadly validate the advice given by hedge fund allocators to avoid managers who purchase fancy sports cars.”

The study has implications well beyond a decision on what kind of due diligence you should pursue when choosing a hedge fund manager. It begs the question: What type of car do you drive? The research suggests that it will tend to convey information on your own investment behavior, behavior that may be damaging to your investment results. Forewarned is forearmed.

By the way, I drive a staid Lexus 430.

This commentary originally appeared February 22 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

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The Three-Step Investor’s Guide to Navigating the Financial Advisory Fiduciary Issue

The Three-Step Investor’s Guide to Navigating the Financial Advisory Fiduciary Issue

By: Tim Maurer

As an educator in the arena of personal finance, I generally avoid matters of public policy or politics because they tend to devolve into dogma and division, all too often leaving wisdom and understanding behind. But occasionally, an issue arises of such importance that I feel an obligation to advocate on behalf of those who don’t have a voice. The issue of the day revolves around a single word: “fiduciary.”

At stake is a Department of Labor ruling set to take effect this coming April that would require any financial advisor, stock broker or insurance agent directing a client’s retirement account to act in the best interest of that client. In other words, the rule would require such advisors to act as a fiduciary. The incoming Trump administration has hit the pause button on that rule, a move that many feel is merely a precursor to the rule’s demise.

Why? Because a vocal constituency of the new administration has lobbied for it—hard. They stand to lose billions—with a “b”—so they’re protecting their profitable turf with every means necessary, even twisted logic.

The good news is that informed investors need not rely on any legislation to ensure they are receiving a fiduciary level of service. Follow these three steps to receive the level of service you deserve:

1) Ask your advisor if he or she acts as a fiduciary.

It’s not a good sign if you get the deer-in-headlights look followed by “Fid-oo-she-WHAT?” If your advisor gets defensive, telling you that you’re better off with the status quo, that’s also concerning.

2) Ask your advisor if he or she acts ONLY as a fiduciary.

One of the biggest challenges facing investors today is that many advisors with a genuine fiduciary label are actually part-time fiduciaries. This is where it gets tricky, because there are at least three different regulatory requirements in the financial industry.

Those beholden to the Investment Advisers Act of 1940 and regulated by the SEC are fiduciaries already, and they have been for a long time. Those who sell securities—typically known as stock brokers and regulated by FINRA—are held to a lesser “suitability” standard. Those who sell insurance products may be beholden to an even lesser standard—caveat emptor, or “buyer beware.”

But what if your advisor is like many who are licensed sufficiently that they may act as a fiduciary when they choose, but may also take off the advisory hat and sell you something as a broker or agent? Do they tell you when they’ve gone from one to the other?

You want a full-time, one-hat-wearing fiduciary.

3) Determine if your advisor is a TRUE fiduciary.

This may be the hardest part, because it requires you to read between the lines. There are advisors who now realize that it’s simply good business to be a fiduciary. And while there’s nothing wrong with profitable business, you don’t want to work with someone just because they’ve realized fiduciary mousetraps sell better than their rusty predecessors.

Not everyone who is a fiduciary from a legal or regulatory perspective is a fiduciary at heart, and yes, it is also true that there are those who are fiduciaries at their core even though they don’t meet the official definition in their business dealings.

You want a practitioner who’s a fiduciary through-and-through—a fiduciary in spirit and in word.

“The annulment of the government’s fiduciary rule would clearly be a setback for investors trying to prepare for retirement,” says sainted financial industry agitate Jack Bogle. “But the fiduciary principle itself will live on, and even spread.”

Yes, the good news—for both advisors and investors—is that there is a strong and growing community of fiduciaries, supported by the Certified Financial Planner™ Board, the Financial Planning Association (FPA) and the National Association of Personal Financial Advisors (NAPFA).

Advisors can join the movement. And investors can insist on only working with a true, full-time fiduciary.

This commentary originally appeared February 24 on Forbes.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

Click here to read the original article.

“Dirty Dozen” List of Tax Scams Released for 2017

“Dirty Dozen” List of Tax Scams Released for 2017

By Michael Kay

The “Dirty Dozen” list of Tax Scams for 2017 has been released by the Internal Revenue Service. Inside this list resides some all too common and devastating tax horrors of which to be aware and vigilant.

The top 4 most common tax scams are: Phishing, Phone Scams, Identity Theft and Return Preparer Fraud. Let’s take them one at a time to make sure you have a seamless tax season.

Phishing
Phishing is a term used to describe a scam that uses fake email addresses and websites specifically designed to steal personal information. We all know emails from the IRS look scary and, worst of all, REAL. Know the facts: The IRS will never send an email teasing big refunds, tax bills or seeking personal information. If you receive an email like this, while you might be tempted to open it, forward it immediately to phishing@irs.gov to help the government track down these rats. Then delete it immediately and get it out of your email system without opening it.

Phone Scams
Phone Scams are phone calls with scammers posing as IRS agents threatening taxpayers with arrest, deportation, and license revocation unless a large sum of “tax” money is paid immediately – over the phone, right then and there. These crooks also use Robo-calls that leave messages instructing you to call back a phone number – and upon doing so, you’ll arrive in the same place; being threatened into paying a fake bill to criminals. Remember, if you do not have a bill in your hand from the IRS with a stated amount due for taxes, you can rely on the fact that the call is a Phone Scam. Threats regarding arrest or law enforcement action is another sign that the caller is not with the IRS, regardless of the ID number they provide you with or information they feed back to you (which is all fake). Know the facts: The IRS will never ask for a credit card over the phone. If you are on the receiving end of this scam, look up www.FTC.gov and go to the FTC Complaint Assistant link or call 800-366-4484.

Identity Theft
Identity Theft has been front and center in the news for years. Yet consumers still frequently fall prey to scammers who are working diligently to get a hold of your personal information. These scoundrels use your name and social security numbers to file false returns to obtain refunds. While the government is working to prevent this, it continues to be a significant problem. There are things you can do to prevent this from happening to you. For example, never put personal information on a website that is not secure, use security software, firewalls and anti-virus protections. Encrypt sensitive files such as tax records, and use strong passwords. Make sure you do not click on unknown links or sites that might contain phishing malware.

Return Preparer Fraud
Return Preparer Fraud. Yes, they exist to perpetrate refund fraud, identity theft and other scams that hurt taxpayers. Choose your preparer carefully by following the following steps:

  1. Ask if the prepare has an IRS Preparer Tax Identification Number (PTIN)
  2. Inquire whether the preparer is a Certified Public Accountant, an Enrolled Agent or Attorney
  3. Check the preparer’s bona fides, use the IRS Directory of Federal Tax Return Preparers with Credentials and Select Qualifications on the IRS website
  4. Check the preparer’s history through the Better Business Bureau for disciplinary action through the appropriate boards (State Board of Accountancy, State Bar Association or through IRS.gov, “Verify Enrolled Agent Status”)
  5. Ask about fees for preparation. If their compensation is tied to your refund—run like your head is on fire!
  6. Ask for your returns to be E-filed.
  7. Never sign a blank return and, for goodness’ sake, review your return before signing, and ask any and all questions. If the preparer is less than enthused about answering, you might want to find another professional.

It is your job to be aware, vigilant and an active participant in your own security and safety. Tax time can be anxiety-ridden and stressful. Don’t let your lack of knowledge or fear lead you into even more danger.

 

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