Weddings and divorces: the scourge of investment returns

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Just as I continue to buy Asian stocks despite losing money, a fortnight ago I got married again. It’s not just my skin in the game anymore. And while I feel like the luckiest man alive, my portfolio risk profile suddenly jumped inversely with my freedom.

This is because the dispersion of potential investment returns has widened. Fortunately, the divorce rate in the UK is a tenth lower for second marriages than for first ones, unlike the US, where it’s 10 per cent higher (weird, huh?). And two weeks later, we’re still talking.

Statistically, though, there’s a one-third chance that we’ll break up. In which case, half of the earnings accrued while married are effectively reduced to zero. My wife gets them. In investment terms, this is similar to an increase in implied volatility, the denominator in many risk-adjusted measures.

Sharpe indices, for example, divide a portfolio’s returns 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 an outperformance.

Fund managers love to flaunt their Sharpe ratios. A high number suggests a cold, steady target when looking for excess returns. Low is shooting at anything that moves. Clients are also inherently excited by the idea of ​​maximizing their profit per unit of risk.

My guess is that few retail bettors ever think about risk-adjusted returns. Sure, you can usually find Sharpe indices for individual funds. But, raise your hand, who adds them at the portfolio level? I certainly haven’t, even though it’s easy to do.

In theory, risk-adjusted returns shouldn’t matter much for investors with medium to long-term horizons. In fact, we focus on them at our peril, in my opinion. As long as you don’t sell too often, or get divorced, volatility should come to the fore.

So beware of a fund with a Sharpe ratio of 1.0 versus a fund of 0.8. It looks more attractive because your excess return of, say, 7 percent comes with volatility of 7 percent, compared to a return of 9 percent and a standard deviation of 11 percent.

But returns pay for your Caribbean cruise, not Sharpe’s low ratios. The 2 percent lost above is nearly a third of the actual return she would expect from the stock each year. Higher returns require more volatility, that’s investing 101.

Hence the nightmare of divorce. The risk of your portfolio increases without the consequent increase in return. If that sounds unromantic and too close to home, what about the marital status of those who manage 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 trade immediately. Because the emotional distraction is so overwhelming, you can automatically subtract 10 to 20 percent.”

I wasn’t exaggerating. In an article in the Journal of Financial Economics, Messrs Lu, Ray and Teo found that after adjusting for other factors, hedge fund managers underperform their pre-split records by nearly 8 percent per year. during the six months between a divorce.

Plus, your risk-adjusted returns are still down by more than 2 percent for a couple of years after that. These numbers were uglier for younger managers and those whose strategies are based on “information networks and interpersonal relationships.”

And the paper doesn’t just suggest that you stop reading this column when my wife runs off with our babysitter. You should ignore my advice now. Unbelievably, getting married itself has an even worse effect on investment performance.

The same data shows an annualized average of 5 percent for the six months around a manager’s wedding day. Similarly, hooked hedgies underperform their antecedents by more than 3 percent per year for two years after saying, “Yes, I do.”

It’s just a fluke that my wallet (sorry honey, our wallet) has been performing as well as it has since I’ve been gone.

Older managers are the most distracted. After a month of entertaining family and friends, then partying until dawn at my wedding, I’m not surprised. This 50-year-old former fund manager can barely remember his name, let alone the difference between leveraged and unleveraged cash flow.

Therefore, it is a coincidence that my wallet (sorry honey, our portfolio) has performed as well as it has since I’ve been gone. Coincidentally, it’s almost exactly the amount we paid for alcohol at our reception. And my friends can drink.

Next week I will go into much more detail about the performance of the seven funds. It’s been another quarter since my last review, and I promised one every three months, both in absolute terms and against relevant benchmarks.

However, it is difficult to get a reading for the last quarter. There was an error transitioning my plans from two employees to one self-managed pension, which also resulted in too much cash floating around. I also added three new ETFs.

Still, the jackpot in total is 7 percent bigger than it was in January. On one hand, that’s depressing. Lots of hard work, thousands of words, dozens of spreadsheets. All for an average number in the single digits, barely above inflation in some places.

On the other hand, the annualized rate doesn’t suck. And we’re 400 basis points above the average single-manager hedge fund so far this year, according to Preqin. Against the average hedge fund pool, we are 600 basis points ahead.

Not that we’re being competitive, but don’t forget that many portfolio managers are yet to be married, let alone divorced. I’ll pick the winners long before their hearts, and subsequent returns, go pop.

The author is a former portfolio manager. Email: stuart.kirk@ft.com; Twitter: @stuartkirk__