Investment

Narcissism, fund managers, and why family offices need to exercise caution when confronted by both

In ancient times, storytellers took a dim view of characters who rated their abilities higher than the gods. Sisyphus was condemned to rolling a boulder up a hill for eternity. Narcissus was escorted to a pool, where he fell in love with his own reflection and never stirred again. 

To this day, narcissism is a challenge to society. It leads to overconfidence and wilful blindness, sometimes persuading autocrats to go to war, utterly confident their views are not only right but will prevail, even when logic dictates otherwise. 

Narcissistic fund managers are inclined to gamble on extreme outcomes and tilt their asset allocation towards riskier stocks without compensating their shareholders

Family offices need to guard against narcissism from their advisers. In his book, Thinking, Fast, and Slow, renowned behaviour theorist Daniel Kahneman recalls a visit to a wealth management group, where he reviewed the performance of its advisers and found they were failing to make a material impact. Behind it, all was over-confidence: “the most significant of the cognitive biases.” 

Family offices have been curtailing access to some pretty overconfident private banks in recent years, with less than three in ten now using their entire product suite, according to a March 2022 survey by BNY Mellon Wealth Management. There has also been a steady move away from active funds and towards passive management and private assets. 

Newly published research, by Dominik Scheld and Oscar Anselm Stolper of Marburg University, has shown how narcissistic tendencies are damaging active management. 

They conclude narcissistic managers are 34% more likely to deviate from their advertised investment styles often due to over-confident bets on growth or small cap shares. 

Narcissistic tendencies in asset management are frequent, possibly because active managers are expected to be confident when trying to beat the index. According to AQR, tech-driven systematic risk management is more consistent. Active managers can add excess returns – in either direction. 

Kahneman points out leaders are often rewarded for behaving in a self-confident manner. We point to the virtues of optimism in starting a business, but overlook the fact that two-thirds of them fail. 

According to Marburg, narcissists underperform by an average of 1% a year. Even when they end up working as part of a more cautious team, their over-confidence influences stock selection and pulls down fund returns: “Narcissists perceive themselves to be superior to others, such that common norms and rules do not apply to them.”

The research adds “Narcissistic fund managers are inclined to gamble on extreme outcomes and tilt their asset allocation towards riskier stocks without compensating their shareholders.”

The researchers reviewed more than 500 verbatim interviews with asset managers conducted by The Wall Street Transcript, scrutinising them for evidence of narcissistic viewpoints. A key test involved their use of the first-person singular (I, mine, my, myself) as opposed to the more inclusive first-personal plural (we, us, our, ours, ourselves).  The data was then compared to returns using Morningstar Direct. The researchers also analysed the length, and pomposity, of LinkedIn profiles, and found a close correlation with their other research. 

The 1% performance cost penalties from over-confidence comes on top of fees and costs from mutual funds of 1.5% or more as well as the impact of other behaviour flaws on performance. This is led by a tendency to liquidate positions prematurely, and in haste, at a potential cost of 1% a year, along with failures to time the market effectively. 

According to Standard & Poor’s, 95% of active US equity funds have failed to beat their benchmarks over the 20 years and international active funds weren’t much better. 

It goes without saying that family offices need to vet their active managers with great care. But you can argue it is scarcely worth retaining them in the first place.

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