Limited Attention, Marital Events, And Hedge Funds
University of Florida
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University of Florida – Warrington College of Business Administration
Singapore Management University – Lee Kong Chian School of Business
We explore the impact of limited attention on investment performance by analyzing the returns of hedge fund managers who are distracted by personal events such as marriage and divorce. We find that marriages and divorces are associated with significantly lower fund alpha, during the six-month period surrounding the event and for up to two years after the event. Relative to the pre-event window, fund alpha falls by an annualized 8.50 percent during a marriage and 7.39 percent during a divorce. Busy fund managers who manage larger funds and engage in high tempo investment strategies are more affected by marriage. Fund managers who depend on interpersonal relationships in their investment strategies are more affected by divorce. We show that behavioral biases may partially explain the connection between inattention and performance deterioration. The difference between the proportion of gains realized and the proportion of losses realized widens during a marriage and a divorce, indicating that inattentive hedge fund managers are more prone to the disposition effect. Taken together, our findings suggest that limited investor attention can hurt the investment performance of professional money managers.
Limited Attention, Marital Events, And Hedge Funds – Introduction
“Almost a quarter of British motorists admit that they have been so distracted by roadside billboards of semi-naked models that they have dangerously veered out of their lanes.” -Reuters (London), November 2005
“One of my No. 1 rules as an investor is as soon as … I find out that [a] manager is going through divorce, [I] redeem immediately. Because the emotional distraction that comes from divorce is so overwhelming. … You can automatically subtract 10 to 20 percent from any manager if he is going through divorce.” – Paul Tudor Jones II, May 20131
Clearly, due to limited attention, motorists are unable to drive within their respective lanes while processing information contained in sexy billboards. Does limited attention also compromise investors’ ability to navigate financial markets? The academic literature has shown that limited investor attention impacts market prices and participants in the following ways. Limited attention shapes investor behavior, causing investors to under-react to earnings announcements (Hirshleifer, Lim, and Teoh, 2009) and purchase high volume and top return stocks (Barber and Odean, 2008). Market participants suffering from limited attention neglect important economic links between supplier and consumer firms (Cohen and Frazzini, 2008) and long-term demographic information (DellaVigna and Pollet, 2007), thereby engendering stock return predictability. Investor inattention drives firm behavior; firms are incentivized to release disappointing earnings news on Fridays so as to take advantage of under-reaction by distracted investors during that time (DellaVigna and Pollet, 2009). Limited attention can explain category learning (Peng and Xiong, 2006), style investing (Barberis and Shleifer, 2003; Teo and Woo, 2004) and co-movement (Barberis, Shleifer, and Wurgler, 2005), and has other asset pricing implications (Hendershott et al., 2013). Yet, there is little evidence to suggest that investor inattention directly compromises investment performance. This paper fills this void by analyzing the impact of limited attention on the investment performance of hedge fund managers.
Hedge fund industry is an interesting laboratory for investigating the impact of limited attention as the complex and dynamic trading strategies that hedge fund managers employ often impose extraordinary demands on a fund manager’s time.2 Consequently, hedge fund investors, such as Paul Tudor Jones II, highly value a fund manager’s ability to stay focused in the investment game. Yet, in order to raise capital and achieve critical mass, hedge fund managers are often side-tracked by capital raising activities such as speaking at hedge fund conferences, attending capital introduction events, and meeting individual investors.
Moreover, as her business grows, a hedge fund manager may find it increasingly difficult to concentrate on her investment duties given the day-to-day demands associated with running a large asset management firm. Indeed, to sharpen their ability to focus in stressful market conditions, some prominent hedge fund managers such as Ray Dalio of Bridgewater Associates and Michael Novogratz of Fortress have taken to meditation.3 We argue that marriage and divorce are deeply personal and largely exogeneous events that distract fund managers from their investment duties.4 Motivated by the Jones’s claim, we examine the release disappointing earnings news on Fridays so as to take advantage of underreaction by distracted investors during that time (DellaVigna and Pollet, 2009). Limited attention can explain category learning (Peng and Xiong, 2006), style investing (Barberis and Shleifer, 2003; Teo and Woo, 2004) and comovement (Barberis, Shleifer, and Wurgler, 2005), and has other asset pricing implications (Hendershott et al., 2013). Yet, there is little evidence to suggest that investor inattention directly compromises investment performance. This paper fills this void by analyzing the impact of limited attention on the investment performance of hedge fund managers.
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