Working paper suggests stock-pickers with successful records suffer as emotional interference sets in
As if the odds against active management success weren’t already stacked high enough, new research suggests that stock pickers with market-beating returns can see their performance dragged down in the face of a particular kind of life disruption.
According to a draft research report to be published by the Financial Research Network (FIRN), individual investors who trade actively and earn superior returns see their performance nosedive in the years leading up to a divorce, reported in the Wall Street Journal.
“The impending divorce has a negative impact,” said Avanidhar Subrahmanyam, professor of finance at UCLA Anderson School of Management, who was among the latest report’s authors.
In their research, Subrahmanyam and his colleagues analysed data in individual investment accounts covering the period from 2000 to 2014, and cross-referenced that with information from divorce records. Their study focused on individuals in Finland who had at least US$1,160 invested, and who were between 25 and 75 years old in the year before their divorce.
The researchers began by identifying the precise date when the courts finalized a couple’s divorce, after which they examined the trading patterns in the investment accounts of the concerned individuals over a 12-month period four to five years before the divorce date. Investors ranking in the top quartile of trading volume during that so-called “clean period” – which the researchers inferred should be devoid of any potential stress related to the divorce – were designated as “active traders,” while the rest were categorized as “inactive traders.”
The researchers also looked at two other timeframes: the “predivorce period,” which was a 24-month period one to three years before the divorce date; and the “divorce period,” a 24-month stretch spanning one year before and one year after the divorce date.
Looking at the investment performance of both active and inactive traders across all time periods, the researchers concluded that the prospect of divorce detracted from active traders’ performance during the predivorce period. But in the two years straddling when the divorce and financial settlement were finalized, active traders’ performance rebounded, suggesting that the distracting influence of the divorce had dissipated.
“It’s almost like the impending divorce is a stressor, and when the stressor is removed the performance comes back to where it was before,” Subrahmanyam told the Journal.
The paper’s findings echo research published in the Journal of Financial Economics in 2016, which unearthed substantial underperformance among hedge-fund managers in the thick of divorce processes. It also aligns with many investment advisors’ real-life experiences of clients making rash decisions or forsaking long-term goals as they go through a divorce.
While Subrahmanyan believes his research can be extrapolated to the U.S., he acknowledged that getting concrete confirmation would be difficult.
“[I]t’s very difficult to link court records with trading records [in the U.S.],” he said.
