Busting the Myth of the Hedge Fund ‘Alpha Male’

By the SMU Social Media Team

The image of the swaggering, alpha male market trader is a persistent one in fiction and in real life, and those in and out of the markets tend to associate the profession with obsessive masculinity, aggression and ruthlessness.

However, a study by Melvyn Teo, Lee Kong Chian Professor of Finance and Deputy Dean (Faculty & Research) at SMU Lee Kong Chian School of Business, and Yan Lu, Assistant Professor of Finance at the University of Central Florida’s College of Business Administration, shows that a high level of testosterone in hedge fund traders actually appears to be negatively correlated with their returns on the markets.

The pair looked at more than 3,000 hedge funds, comparing their performance over a 22-year period with their managers’ facial-width-to-height ratio (fWHR)—a well-established proxy for testosterone.

They found that high-testosterone managers significantly underperform low-testosterone managers—by 5.8 per cent per year— and they are more likely to terminate their funds or commit regulatory breaches or civil and criminal violations.

“First, high-testosterone managers tend to gravitate towards lottery-like stocks which ultimately deliver lower returns on average,” Prof Teo says. “Second, high-testosterone managers are more susceptible to behavioural biases such as the disposition effect. Disposition prone managers tend to hold on to their losing positions for too long and are too quick to realise their gains.”

In short, high-testosterone managers appear more likely to take unnecessary risks, to be too slow to admit their mistakes, and too impatient to book their gains.

“Our sense is that these tendencies are related to the greater aggression and egocentrism of high-testosterone managers,” Prof Teo says.

As Prof Teo and Asst Prof Yan point out in their research, the hedge fund industry is a “compelling laboratory”, given the relative free rein that managers are given to trade what they like and how they like. The industry is relatively opaque and has comparatively little regulatory oversight. It is also characterised by an obsession with masculinity—aggression, physical prowess and competitiveness are highly prized traits. Research in 2014 by Leanne Cutcher and Kathleen Riach found that ageing male traders often obsessively work out because they feel that physical capability is linked to their success.

“…high-testosterone managers tend to gravitate towards lottery-like stocks which ultimately deliver lower returns on average.”

There is literature to support the idea that behaviours associated with high levels of testosterone do have a positive impact on some areas of business. Research shows that company CEOs with high fWHR do deliver higher return on assets; although they are also more likely to take risks and to engage in financial misreporting.

However, it transpires that these traits are in fact deleterious to the performance of investment managers. Prof Teo says that his research is backed up by other studies which show in laboratory settings that testosterone can lead individuals to make irrational risk-reward tradeoffs.

There is more than US$3.3 trillion worth of assets under management in hedge funds around the world, and, as Prof Teo’s research shows, many are more exposed to so-called ‘operational risk’—the potential for non-market related problems that can hurt their investments—than they think.

The report concludes that investors should eschew the conventional wisdom, that aggressive alpha males do not, in fact, deliver alpha on their hedge fund investments. However, as Prof Teo says, at the moment very many of them are not doing so, and the myth of the masculine trader still persists, partly because it has become self-reinforcing.

“These behaviours have persisted because high-testosterone investors supply capital to high-testosterone fund managers. We find that managers of fund of hedge funds [who invest in multiple hedge funds] with high fWHR tend to also invest in hedge funds operated by managers with high fWHR,” he says. “We hypothesise that this is due to the fact that the aggressive trading styles of high-testosterone hedge funds appeal to high-testosterone investors. Since these high-testosterone hedge funds have a captive audience, they do not simply die off and are able to persist.”