In “Sensation Seeking, Sports Cars, and Hedge Funds” Three business school researchers analyze a huge data-set of previous and current hedge-funds that have been hand-matched with the vehicle-ownership records of the funds’ managers and analyze the data to see if the ownership of a “performance car” correlates with a hedge fund manager’s willingness to take risks, and whether those risks pay off.
The results are startling and clear: sports-car ownership is strongly correlated with extremely unwise risk-taking, while ownership of boring cars like minivans is correlated with prudent risk-aversion that pays a higher dividend to investors — and the sports-car owners are also significantly more likely to be caught engaged in fraud.
The empirical results are striking. We find that hedge fund managers who purchase
performance cars take on more investment risk than do fund managers who eschew performance
cars. Specifically, sports car drivers deliver returns that are 1.80 percentage points per annum
more volatile than do non-sports car drivers. This represents a 16.61 percent increase in volatility
over that of drivers who shun sports cars. Similarly, drivers of high horsepower and high torque
automobiles exhibit 1.14 and 1.25 percentage points per annum more volatility, respectively, in
the funds that they manage than do drivers of low horsepower and low torque automobiles. The
increased risk taking by performance car enthusiasts cannot be attributed to the usual factors that
shape hedge fund investment behavior such as fund age (Agaarwal and Jorion, 2010), size (Berk
and Green, 2004), incentives (Agarwal, Daniel, and Naik, 2009), and share restrictions (Aragon,
2007). After controlling for these factors in multivariate regressions, we still find that the crosssectional
risk differences between performance and non-performance car owners are economically and statistically significant. Differences in systematic risk do not explain our
results since our findings prevail after we adjust for co-variation with the Fung and Hsieh (2004)
seven factors and examine idiosyncratic risk. Our findings are also not driven by other factors
such as backfill bias (Liang, 2000; Fung and Hsieh, 2009; Bhardwaj, Gorton, and Rouwenhorst,
2014), serial correlation in fund returns (Getmansky, Lo, and Makarov, 2004), and manager
manipulation of fund returns (Bollen and Pool, 2008, 2009; Aragon and Nanda, 2016), that could
cloud inferences made from reported returns. These results suggest that managers who procure
cars with attributes that signal a preference for sensation seeking deliver more volatile returns.
Is the inverse also true? Do hedge fund managers who purchase cars with attributes that
suggest an aversion to sensation seeking deliver more stable returns? We find that managers who
acquire practical but unexciting cars take on lower investment risk relative to managers who
shun these cars. In particular, minivan owners generate returns that are 1.28 percentage points
per annum less volatile than do other owners. This represents an 11.74 percent reduction in risk
relative to managers who eschew minivans. Moreover, managers who purchase cars with high
passenger volumes and excellent safety ratings also deliver returns that are on an annualized
basis 1.59 and 0.97 percentage points less volatile, respectively, than do managers who purchase
cars with low passenger volumes and poor safety ratings. These results remain economically and
statistically meaningful after we control for the myriad of factors that may drive fund manager
investment behavior or taint inferences derived from reported returns. To the extent that the antisensation
vehicle attributes (i.e., minivan, passenger volume, and safety rating) signal a penchant
for sensation avoidance, these results complement those based on the pro-sensation vehicle
attributes (i.e., sports car, horsepower, and torque). We carefully consider several alternative
explanations for our findings, including reverse causality, social status or wealth (Piff et al.,
5
2012), marital status (Love, 2010; Roussanov and Savor, 2014), and manager age (Barber and
Odean, 2001), but find that they are unlikely to drive the bulk of our results.Does the incremental risk-taking by sensation seekers translate into higher returns? We
find that despite taking more investment risk, fund managers who purchase performance cars do
not harvest greater returns than do fund managers who eschew those cars. Consequently, buyers
of cars with pro-sensation attributes deliver lower Sharpe ratios than do buyers of cars with antisensation
attributes. For example, a one standard deviation increase in vehicle maximum
horsepower is associated with a decrease in fund annualized Sharpe ratio of 0.18. This represents
a 21.43 percent reduction relative to the Sharpe ratio of the average fund in our sample. In
contrast, a one standard deviation increase in vehicle passenger volume is associated with a 0.18
increase in fund annualized Sharpe ratio. Anecdotal evidence suggests that institutional investors
emphasize performance metrics like the Sharpe ratio when evaluating fund managers. These
empirical results broadly validate the advice given by hedge fund allocators to avoid managers
who purchase fancy sports cars.
Sensation Seeking, Sports Cars, and Hedge Funds[Stephen Brown, Yan Lu, Sugata Ray and Melvyn Teo/SSRN]
(via Marginal Revolution)