The perils of investing with your politics James Saft

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In investing, it seems, the wages of following your political bias is higher volatility without higher returns. That’s the upshot of a new study, which tracks how heavily fund managers allocate assets into firms managed by people with whom they agree politically. (here)Fund managers do tend to opt for firms with which they are in political alignment, the study finds, and do so more when their own party controls the White House. As more risk without more reward is the investing opposite of a free lunch, this extra volatility politically biased mutual fund managers create is a cost and a problem for fund holders. As the Trump rally seemingly falters, now may be a good time to consider some of the factors which may have undergirded the surge in stocks on his election. The new study, by M. Babajide Wintoki and Yaoyi Xi of the University of Kansas, looked at a sample of 1,298 mutual fund managers between 2000 and 2015, using political donations as a proxy by which to see if they invested more or less in firms managed by executives with similar political views. The answer, perhaps unsurprisingly, was yes. Republican-leaning managers put about 8 percent more into Republican-leaning firms than do Democratic-leaning managers, the study found. Those same Republican-leaning managers also put about 3 percent less into Democratic-leaning firms than do their Democratic-supporting peers. Funds whose managers have an identifiable political leaning hold 43 percent of assets in firms whose management align with their bias and only 33 percent in firms whose managers lean the other way.

So, people put their, or their clients’, money where their political beliefs are. How’s that working out?“We find that mutual funds that have more holdings in politically similar firms tend to perform worse than those with less partisan bias, although the economic magnitude of this underperformance is small. However, we find that partisan bias actually leads to statistically and economically significantly higher levels of fund idiosyncratic volatility,” the authors write. For every one standard deviation increase in partisan holdings funds suffer about a 29 percent increase in idiosyncratic volatility. Love Trump or hate him, love Hillary or want her jailed, that is not what fund managers are paid to do. FAMILIARITY OR ADMIRATION/CONTEMPT

This result lines up well with some other recent research into the impact of political bias on investing. A 2016 paper found that investors become more optimistic and see the markets as undervalued and holding less risk when their party is in power. (here)Another 2016 paper found Republican-leaning fund managers badly lagged Democratic ones just after Barack Obama was elected and took office, a phenomenon the authors theorize was driven by a tendency to over-weight fears about hyperinflation aired by right-wing media at the time. (here)Looking at the George W. Bush and Obama administrations, the Kansas study found that managers with a political bias tend to over-allocate into politically similar firms more when their party controls the White House. The question about all of this is why fund managers do this. One potential explanation is that political activity serves as a channel through which fund managers get better information about firms whose managers are also in their camp. It is also possible that they are simply more familiar with those firms but don’t have better information.

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