Loss averse fund managers are far more likely to get fired than their more aggressive colleagues according to a recent study which found that 36% of the most risk averse managers were ‘involuntarily terminated’ over an eight-year period compared to just under 6% for the least loss averse. But that’s not necessarily bad news for those funds’ clients.

“Funds managed by managers with higher aversion to losses take on less downside risk and have lower risk-adjusted returns. More loss averse managers are more likely to have their contracts terminated,” University of Notre Dame assistant professor Andriy Bodnaruk and Michigan State University assistant professor Andrei Simonov in their paper Loss Averse Preferences, Performance, and Career Success of Institutional Investors.

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Testing loss aversion with a series of lotteries

The notion that professional investors are rewarded for taking risks isn’t exactly a shock, but it’s hard to disentangle manager biases, investor preferences, and fund mandates. To get around this, Bodnaruk and Simonov sent out surveys asking Swedish fund managers whether they would take part in a lottery that gave equal odds of winning 30 SEK (about $5 at the time) or losing 20 SEK, and whether they would take part in a similar lottery made up of six repetitions of the previous wager.

In both cases the expected value is positive, but the second setup also has less than 50% odds of netting a loss. Of the 68 managers who responded, 25 rejected both offers, 26 rejected the first and accepted the second, and 17 accepted both. What makes the research interesting is that these surveys were done in 2004, so Bodnaruk and Simonov were able to go back and check back on how the managers fared eight years later.

Least loss averse managers go to hedge funds

There was some sorting in the results. The most loss averse managers (those that rejected both lotteries) were more likely to end up at fixed income and balanced funds, while the least loss averse went to hedge funds. Even so, the most loss averse were six times more likely to be terminated (though some of them found new positions with smaller funds). Another way to see this is that the most experienced managers tend to be the least loss averse. That could partly be due to experienced managers becoming more accustomed to risk, but it also seems that if you want to get to get to the ‘experienced’ part of the career arc you will have to learn to live with risk.

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See full study here.