As I keep buying Asian stocks despite losing money, I remarried two weeks ago. My skin is no longer the only one in the game. And while I feel like the luckiest person out there, the risk profile of my portfolio has suddenly spiked with my freedom.
This is because the spread of potential investment returns has widened. Fortunately, the divorce rate in the UK is a tenth lower for second than first marriages, compared to the US where it is 10 per cent higher (strange, huh?). And two weeks later, we’re still talking.
Statistically, however, there is a one-third chance that we will split up. In this case, half of the profits accumulated during my marriage will practically be reduced to zero. My wife gets them. From an investment perspective, this is similar to an increase in implied volatility, which is the denominator of many risk-adjusted measures.
Sharpe ratios, for example, divide a portfolio’s return above the risk-free rate by the standard deviation of those returns. In other words, how much risk or volatility is being used to generate better performance.
Fund managers like to flaunt their Sharpe ratios. A high number suggests a cold and solid purpose when hunting for extra returns. Low shoots anything that moves. Clients also basically welcome the maximization of profit per unit of risk.
My guess is that few retail bettors think about risk-adjusted returns. Of course, you can usually find Sharpe ratios for each fund. But hands up, who aggregates these at the portfolio level? I certainly don’t, even though it’s easy to do.
In theory, risk-adjusted returns don’t matter much to medium- and long-term investors. In fact, in my opinion, we focus on them at our own peril. Provided you don’t sell too often – or get divorced – the volatility should come out in the wash.
So watch out for a fund with a Sharpe ratio of 1.0 while another has a ratio of 0.8. It looks more attractive because the excess return of 7 percent has a volatility of 7 percent, compared to a return of 9 percent and a variance of 11 percent.
But it’s the yields that pay for the Caribbean cruise, not the low Sharpe ratios. The above 2 percent fell short of nearly a third of the real return expected from shares. Higher returns require higher volatility – that’s investing 101.
Hence the nightmare of divorce. Portfolio risk increases without an associated increase in performance. If that sounds romantic and hits too close to home, what about the marital status of those handling your money?
Hedge fund titan Paul Tudor Jones once said that “one of my number one rules as an investor is that as soon as I know a manager is going through a divorce, I immediately switch back. Because the emotional distraction is so overwhelming, it can automatically deduct 10 to 20 percent.”
Not excessive. In a study in the Journal of Financial Economics, Messrs. Lu, Ray and Teo found that, after adjusting for other factors, hedge fund managers underperform their pre-divorce performance by almost 8 percent annually in the six months post-divorce.
Moreover, their risk-adjusted returns will underperform by more than 2 percent for a few more years after that. Those numbers were uglier for younger managers and those whose strategies rely on “information networks and interpersonal relationships.”
And the paper doesn’t just suggest you stop reading this column when my wife runs off with our nanny. Now you should ignore my advice. Unbelievably, marriage itself has an even worse effect on return on investment.
The same data shows an average annualized hit of 5 percent in the six months surrounding the manager’s wedding. Similarly, hanging hedge ropes underperform by well over 3 percent per year for two years after they say “Yes.”
Older managers are the ones who bother me the most. After a month of entertaining family and friends, and then partying until sunrise 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 unlevered cash flow.
So it’s a coincidence that my portfolio (sorry, dear, ours portfolio) is doing as well as it has since I’ve been gone. Coincidentally, it’s almost exactly more than what we paid for the booze at the reception. And my friends can drink too.
Next week, I’ll cover the performance of each of the seven funds in much more detail. Another quarter has passed since my last review, and I promised one every three months, both in absolute terms and against relevant benchmarks.
However, it is difficult to read about the last quarter. There was such a faff that I converted my two employee plans into an independent pension, which also floated too much cash. I also added three new ETFs.
Despite this, the bank is 7 percent larger in total than it was in January. On the one hand, it’s depressing. A lot of hard work, thousands of words, lots of tables. All this for a mid-single-digit number – in some places it barely exceeds inflation.
On the other hand, the annualized interest rate doesn’t stink. According to Preqin, we are 400 basis points away from the average single-manager hedge fund to date. We are 600 basis points ahead of the average fund of hedge funds.
Not that we’re being competitive, but let’s not forget that many portfolio managers are never married, let alone divorced. I will return again to pick winners, well before their hearts, and subsequent returns, go pop.