Women and Alpha: “Money Is on Everybody’s Mind”

On 18–19 September, CFA Institute will host Alpha and Gender Diversity 2017 in Toronto, the latest in its series of Women in Investment Management events. Attendees will have opportunities to discuss gender diversity, foster professional development, and meet their peers from other regions in North America.

Have you ever wondered why women and men make different investment decisions and what effect, if any, this has on alpha?

It’s an interesting, albeit contentious topic that is rife with disagreement. Case in point: “Many studies find that female money managers are more risk averse than their male colleagues, although a growing body of evidence speaks to the contrary,” notes a recent white paper, Addressing Gender Folklore.

Meredith Jones, author of Women of the Street: Why Female Money Managers Generate Higher Returns, believes there are three primary reasons why women and men tend to approach investing differently: biology, cognition, and behavior. And she says that if we, as an industry, are focused on minimizing risk and maximizing return, “we should at least consider the idea that cognitive and behavioral alpha do exist and pursue them through allocations to women (and minority) fund managers.”

1. Biology

“Testosterone is a pretty big impact player in terms of how men approach the market,” Jones told delegates at the recent Women in Investment Management Conference in San Antonio, Texas. She noted that women only have about 10% of the testosterone of men and it’s this hormone that leads to a phenomenon known as the “winner effect.” The “winner effect” describes how an animal that has won a few fights against weaker opponents is more likely to pick more fights as the successes pile up thanks to rising testosterone levels. But at some point, the winning streak comes to an end. (For more on the effects of testosterone and cortisol, see “The Truth Behind Testosterone: Why Men Risk It All.” Also, this write-up of John Coates’s keynote address on the biology of risk-taking at the 68th CFA Institute Annual Conference.)

As Jones explained, “The way [the winner effect] works in the market is that the research shows that almost every single big market blowup has been caused by a young male trader after a winning streak.”

2. Cognition

“The way that [men and women] process information is, in fact, different,” said Jones. “We hear a lot that women are more risk-averse than men . . . It’s kind of a backhanded compliment, and usually what people mean by that is ‘Yes, I think you can do a very good job with my money, but I know you’re never really going to make me high returns.'” This, she added “is utter bunk” because women can and, in fact, do generate very high returns.

“The whole risk-aversion myth comes from differences in probability weighting, primarily. Women weight probabilities differently, their probability curve is much flatter, they are less likely to overestimate prices and price targets of their investments, and they do a much better job of matching their expected return with their actual alpha,” said Jones. “As a result, they are taking risk, but they are taking calculated risk.”

Jones pointed to research in her book, noting that over a six-and-a-half year period, female-run hedge funds generated a six percentage point differential in terms of performance, while in private equity, there was a one percentage point differential. “If you look at a study of brokerage accounts there is between a 1% and a 2% performance differential between men and women. If you look at IRAs, particularly during the financial crisis, there was a three percentage point differential,” she said. “This outperformance is real. So it’s not that women can’t generate these high returns, it’s that they are doing it in a different way.”

Women also tend to be less overconfident than men, she said: “It’s not that they are not confident; they are not overconfident, and that actually turns out to be a good thing because overconfident investors tend to act on every single idea that they have.”

3. Behavior

Studies have found that women trade less than male managers, are less likely to sell into market noise, and tend to be longer term investors, Jones said. “Behavior is such an important part of investing. We all tend to think about investing from the terms of ‘Can I find a good strategy? Can I find somebody who is really skilled?'” she added. “But we don’t really think about how behavior can create alpha. And so as we look at portfolios, and as our clients look at portfolios, I think we have to realize that our behavior has an impact on what we do, the people that we invest in also has an impact on what we do, and collectively all of our behavior impacts macroeconomic factors.”

And she asked: Doesn’t it make sense to have behavior that is different and diversified, as opposed to having people who are all going to tend to start taking more risk when they get into to a stressful part of the market?

“It is very important to have that cognitive alpha so that we can achieve strong returns and also to have that behavioral diversification so that we can mitigate the volatility in the market.”

Why Does Any of This Matter?

“Money is on everybody’s mind,” Jones said.

She pointed out that many pension funds are underfunded and that, by some estimates, Americans are under-saved for retirement by up to $14 trillion. “So any time we can think of a way to squeeze any additional alpha out of a portfolio, any time we can think of a way to squeeze any additional diversification out of a portfolio, in my thinking, we should be doing that,” she said. “And one of the ways that we can do that is to invest in more women.”

Diversity is good for business. Jones believes that it’s key to not only have a diversified portfolio of investments with different and diversifying strategies and instruments, but also to have investment managers who will behave differently when approaching the markets. And that’s where women come in.

As she quipped: “The rooster may crow, but the hen delivers the goods.”

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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