Political ideology, translated into psychological behavior, could influence portfolio decisions for even the most sophisticated investor, according to a paper.
There is a strong correlation between a hedge fund manager’s politics and stock selection style, argued finance researchers Luke DeVault and Richard Sias of the University of Arizona.
“Relative to conservatives, liberals are more tolerant of ambiguity and uncertainty, more open to new experiences, have lower levels of fear, exhibit higher integrative complexity, and have lower needs for order, structure, and closure,” the authors said.
As such, politically conservative hedge funds—measured by reported contributions to the Republican and Democratic parties—were likely to be more traditional in their long-equity portfolios than their liberal counterparts.
“Relative to conservatives, liberals are more tolerant of ambiguity and uncertainty, more open to new experiences, and have lower levels of fear.”
Of nearly 500 hedge fund groups with political contributions totaling $43 million, the authors found liberal managers’ portfolios generally took on more risk.
Specifically, their long-equity portfolios had greater exposures to smaller and high-volatility stocks, and younger, unprofitable, and non-dividend-paying companies, the authors said.
In addition, politically liberal hedge fund managers more easily entered and exited new equity exposures and tended to make larger shifts in US equity allocations.
“We interpret the link between hedge funds’ political orientations and their security selection and portfolio decisions as reflecting the relation between psychological characteristics and attitudes toward financial risk-taking,” DeVault and Sias said.
Data showed hedge fund characteristics—including leverage, lockups and fund style—had little impact on managers’ psychological qualities already influenced by political leanings. Liberal funds’ risk-taking remained higher than their conservative counterparts, while turnover rates were on equal footing.
Managers’ personal characteristics also failed to change how political preferences influenced their stock pickings, according to the research. Even when controlled for age, gender, and education level, liberal hedge funds were likely to be more risk tolerant.
Read the full paper here.
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