In the politically charged atmosphere of our day, especially in the United States since the most recent presidential inauguration, it would be unwise to presume that hedge fund managers are exempt from political cognitive biases, or that these biases leave their portfolio decisions unaffected.
Marian Moszoro and Michael Bykhovsky co-wrote a fascinating article on the issue of such cognitive biases last summer. Dr. Moszoro is a former Deputy Minister of Finance for Poland, and is now a visiting scholar at Harvard Law School and a faculty affiliate at Cornell University, Program in Infrastructure Policy. Mr. Bykhovsky is a former CEO of Applied Financial Technology and currently is the president of a non-profit advocacy group, the Center for Open Economics.
Moszoro and Bykhovsky took a close look at data from the last time around in the political cycle – the last time one party (and, one might fairly say, one political philosophy) replaced another in the White House: the period soon after President Barack Obama’s first inauguration in January 2009.
The transition between presidencies that time took place in the vise of a global financial crisis, and as the Federal Reserve, in compliance with the wishes of both the outgoing and the incoming administrations, expanded the supply of U.S. dollars in circulation: “quantitative easing,” as it was called.
Fear of Hyperinflation
Moszoro and Bykhovsky’s point is that interpretations of this fact created an “exceptionally wide partisan divide.” On the one side commentators politically opposed to the new administration predicted hyperinflation. On the other side, they proved “muted in their response” or defended the QE.
The question then is: did that partisan divide show up in investment decisions as a cognitive bias? If managers are rational, as rationality is generally understood in economics, one would not expect so.
But these authors tell us that they do find “differences in funds’ performances depending on the political preferences by the managers.”
The authors define the political leanings of the managers included in their database by campaign contributions. This, as they acknowledge, might be a methodological bone that critics might want to pick. After all, a manager might have given money to the Obama campaign on the calculation that (or just hedging against the possibility that) he would win, and that in such a case it would be good to have a friendly ear in the Oval Office. A contribution does not logically imply political affiliation.
But these authors restricted their analysis to the managers who contributed solely to one side or the other. Presumably, this makes partisan affiliation more likely than strategic calculation as an explanation of the contribution: strategic contributors contribute to both sides with that hedging intent.
On the presumption then that univocal contribution is a decent proxy for the partisan/philosophical orientation and possible cognitive bias, these authors find that the Democratic managers outperformed the Republican managers between December 2008 and September 2009 by approximately 7% annualized, because Republican managers were expecting inflationary consequences of QE that didn’t arrive. This was as they say “a high price paid by Republican managers and their clients to maintain a consistency of beliefs.”
Ten Months Out of Sixteen Years
These authors note, too, that the ten-month period at issue is an anomaly. They analyzed sixteen years, and found that the ten-month period starting the month after Obama’s first election was the only time in those years “when Democratic equity hedge fund managers outperformed their Republican counterparts by at least 10 basis points with a probability of %1 or lower that it was by chance.”
The authors consider (very briefly) alternative explanations for the disparity during this window. Perhaps the outperformance by Democratic managers arose not from their disbelief in hype but from their better connections. This possible explanation breaks down into their receipt of insider information about Congressional or presidential plans on the hand, or the superior effectiveness of their informal social network on the other.
Yet neither of those explanations really accounts for the specificity of the window of partisan divergence at issue here, in the way that differing cognition regarding monetary policy does.