Weddings and divorce: the scourge of investment returns
Just as I keep buying Asian stocks despite losing money, a fortnight ago I remarried. No longer is it my skin in the game alone. And while I feel like the luckiest man alive, the risk profile of my portfolio has suddenly jumped inversely with my freedom.
That is because the spread of possible investment returns has widened. Thankfully, the divorce rate in the UK is a tenth lower for second versus first marriages, as opposed to the US, where it is 10 per cent higher (weird, eh?). And two weeks later, we’re still speaking.
Statistically, however, there is a one-third chance we will split. In which case half of any gains accrued while I’m married effectively reduce to zero. My wife gets them. In investing terms, this is akin to a rise in implied volatility, the denominator in many risk-adjusted measures.
Sharpe ratios, for example, divide the returns a portfolio makes above a risk-free rate by the standard deviation of those returns. In other words, how much risk or volatility is being used to generate outperformance.
Fund managers love to flaunt their Sharpe ratios. A high number suggests a cool and steady aim when hunting excess returns. Low is firing at anything that moves. Clients too, intrinsically warm to the idea of maximising their gains per unit of risk.
My guess is that few retail punters ever think about risk-adjusted returns. Sure, you can usually find Sharpe ratios for individual funds. But hands up who aggregates them at a portfolio level? I certainly haven’t, despite it being easy to do.
In theory, risk-adjusted returns shouldn’t matter much for investors with medium to long-term horizons. Indeed, we focus on them at our peril, in my opinion. Provided you don’t sell too often — or get divorced — the volatility should come out in the wash.
So beware a fund with a Sharpe ratio of 1.0 compared with another at 0.8. It seems more attractive because its excess return of, say, 7 per cent comes with 7 per cent volatility, compared with a 9 per cent return and a standard deviation of 11 per cent.
But returns pay for your Caribbean cruise, not low Sharpe ratios. The forgone 2 per cent above is almost a third of the real return you would expect from equities each year. Higher returns require more volatility — that’s investing 101.
Hence the nightmare of divorce. The risk to your portfolio increases without the concomitant rise in performance. If that sounds unromantic and too close to home, what about the marital status of those managing your money?
Hedge fund titan Paul Tudor Jones once said that “one of my number one rules as an investor is as soon as I find out a manager is going through a divorce, I redeem immediately. Because the emotional distraction is so overwhelming, you can automatically subtract 10 to 20 per cent.”
He wasn’t exaggerating. In a Journal of Financial Economics paper, Messrs Lu, Ray and Teo found that after adjusting for other factors, hedge fund managers underperform their pre-separation track records by almost 8 per cent a year over the six months straddling a divorce.
What is more, their risk-adjusted returns keep underperforming by more than 2 per cent for a couple of years after that. These numbers were uglier for younger managers and those whose strategies rely on “information networks and interpersonal relationships”.
And the paper doesn’t only suggest you should stop reading this column when my wife runs off with our nanny. You should ignore my advice now. Incredibly, the event of getting married itself has an even worse effect on investment returns.
The same data shows an average 5 per cent annualised hit over the six months around a manager’s wedding day. Similarly, hitched hedgies underperform their track records by well over 3 per cent per annum for two years after they say: “I do”.
Older managers are distracted most. Following a month of entertaining family and friends, then partying until sunrise at my wedding, I’m not surprised. This 50-year-old ex-fund manager can barely remember his name, let alone the difference between levered and unlevered cash flow.
Thus it’s a fluke that my portfolio (I’m sorry darling, our portfolio) has been performing as well as it has since I’ve been away. Coincidentally, it is up by almost exactly the amount we paid for booze at our reception. And my friends can drink.
Next week I will go into much more detail on the performance of all seven funds. Another quarter has passed since my last review, and I promised one every three months, both in absolute terms and versus relevant benchmarks.
It is hard to get a read on the last quarter, though. There was the faff in transitioning my two employee plans into a self-managed pension, which also resulted in too much cash floating around. I added three new ETFs too.
Still, the pot in total is 7 per cent bigger than it was in January. On one hand, that’s depressing. A lot of hard work, thousands of words, scores of spreadsheets. All for a mid-single digit number — barely above inflation in some places.
On the other hand, the annualised rate doesn’t stink. And we’re 400 basis points clear of the average single manager hedge fund year to date, according to Preqin. Against the average fund of hedge funds, we’re 600 basis points ahead.
Not that we’re being competitive, but don’t forget that many portfolio managers have yet to marry, let alone divorce. I’ll be back to picking winners again well before their hearts, and subsequent returns, go pop.
The author is a former portfolio manager. Email: firstname.lastname@example.org; Twitter: @stuartkirk__