Financial markets are notoriously unsympathetic. Of course, they are merely factors of their participants’ actions. A 2012 article in the CFA Institute’s magazine estimated that 10% of financial services professionals were psychopaths, compared with just 1% of the general population, while a 2011 experiment out of the University of St Gallen found that professional traders were more willing to hurt their rivals than diagnosed and incarcerated psychopaths were.
So it is sadly unsurprising that, confronted with the devastation and misery wrought by hurricanes Harvey and Irma, some commentators have ventured opinions on how to ‘play’ these disasters. Indifference to the suffering can also be seen in those bidding up refinery shares in response to the news, or selling insurers and travel stocks.
Many of these investors will simply think of this as discharging their fiduciary duty to act in the best interests of their clients. But how do money managers directly affected by these calamities react? Given that Houston and Miami are major financial centers, some portfolio managers are likely to have been caught up in Harvey and Irma.
Although the wellbeing of everyone caught up in these disasters is obviously the priority, a timely new paper – published in late August by Gennaro Bernile of the University of Miami, Vineet Bhagwat of the George Washington University, and Ambrus Kecskés and Phuong-Anh Nguyen of York University, Toronto – explores the impact of catastrophes on funds.
The academics looked at international equity funds based in US counties that had experienced extreme weather – defined as the worst 0.1% of events by fatalities or property damage. They focused on international portfolios so that managers’ subsequent behavior could not be attributed to any direct effect of these tragedies on their holdings: for example, flooding in New York may be legitimately detrimental to some US stocks but is unlikely to change the long-term outlook for a European pharmaceutical group or an emerging-market technology business.
Starting with the point at which managers experienced a crisis in their county, the researchers looked back to check whether their performance prior to the catastrophe had been significantly different from that of their peers in non-afflicted counties. They found that it had not, indicating that there was nothing particularly risky or risk-averse about these managers before the disaster struck their county.
But once the emergency hits, these managers became much more defensive than their counterparts elsewhere. In the first year after a disaster, the monthly volatility of their funds fell by an economically significant 60 basis points compared with their unaffected competitors. This continued into the second year too, with volatility among disaster-hit managers 35 basis points lower than their peers. However, the two groupings were level again by the third year. In line with this lower volatility, managers who experienced catastrophes in their counties also generated monthly raw returns 13 basis points below their peers in the first year, although this was not statistically significant.
Shell-shocked or cynical?
The authors advanced a number of theories explaining why this should be the case. ‘A natural interpretation of our results is that exposure to severe disasters induces emotional responses by fund managers that lead to more conservative stock selection,’ they suggested. It is not the only possibility, though.
Another is that the managers respond to a perceived market demand for less risk following a domestic crisis. This could be driven by the funds’ clients, who may also have been hurt by the disaster, or by the managers themselves, if they suspect the catastrophe will harm US stocks relative to international ones. If so, they could be motivated to take less risk in their portfolios on the presumption that they won’t have to push so hard to outperform US equities and attract flows.
In either case, Bernile, Bhagwat, Kecskés and Nguyen found no significant impact on fund flows following these extreme events. Nevertheless, investors may still be interested to know that managers personally affected by disasters seem to become more cautious with their portfolios.