Professor Melvyn Teo of Singapore Management University, Professor Stephen Brown of New York University, Assistant Professor Yan Lu of University of Central Florida, and Assistant Professor Sugata Ray of University of Florida use a novel dataset on automobile purchases by hedge fund managers to investigate the effects of sensation seeking on investment behavior.
Sensation seeking is a personality trait defined by the seeking of varied, novel, complex, and intense sensations and experiences, and the willingness to take physical, social, legal, and financial risks for the sake of such experience. The authors argue that the purchase of a powerful sports car conveys the intent to drive in a spirited fashion and therefore signals a propensity for sensation seeking.
Consistent with the sensation seeking view, they find that hedge fund managers who own high performance cars take on more investment risk than do other fund managers. 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 greater volatility than do other drivers.
Conversely, managers who acquire practical but unexciting cars take on less 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. Moreover, managers who purchase cars with high passenger volumes and excellent safety ratings also deliver returns that are more stable relative to other managers.
Despite taking more investment risk, managers who purchase performance cars do not harvest greater returns than do managers who eschew those cars. Therefore, performance car owners deliver lower Sharpe ratios than do non-performance car owners. The incremental risk-taking by sports car enthusiasts extends beyond financial markets to the fund operations arena as well. Performance car drivers are more likely to terminate their funds and report violations on their Form ADVs. Conversely, drivers of practical but unexciting cars are less likely to shut down their funds and report violations on their Form ADVs.
Sensation seeking also impacts fund manager trading behaviour. Hedge funds managers who embrace powerful sports cars trade more frequently, actively, and unconventionally than do managers who eschew such cars. Trading hurts the performance of sensation seekers more than it hurts the performance of non-sensation seekers. This suggests that sensation seekers may be more prone to overconfidence.
The findings empirically validate the advice given by some hedge fund allocators to avoid fund managers who drive fancy sports cars. The results indicate that fund manager vehicle ownership data offer rich insights into managers’ intrinsic and non-pecuniary motivations for taking financial and operational risk. They also have significant practical relevance for hedge fund investors such as pension funds, endowments, and family offices, as well as hedge fund recruiters, consultants, and allocators.