Belief and Risk: The Influence of Religion on Mutual Funds

Published on: 10/01/2012
Posted on: 10/25/2012
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More influences are impacting one's mutual fund performance than just the stocks and bonds in the portfolio and the sways of the economy. Risk, reward and values may have a new calculus. In new research, SMU Cox Finance Professor Johan Sulaeman and co-authors find that the impact of religious beliefs on mutual fund volatility is economically significant.
Local culture, as measured through the proxy of religious belief, has a notable impact on mutual fund behaviors and the managers that run them.

A lineage of study sprang forth from Max Weber's "The Protestant Ethic and the Spirit of Capitalism" published in 1930. He believed Northern European countries, Britain, Germany and the Scandinavian ones, were successful economically because of their Protestant work ethic. This idea motivated the many studies on the effects of religious beliefs that followed. In more recent times, studies have compared Catholic, Jewish and Protestant groups to assess which group, based on religious belief, were bigger risk takers. In this new study, some earlier findings are echoed. Catholics exhibit less aversion to speculative risk than the average population; and Protestants tend to be more averse to speculative risk.

According to Sulaeman, "In general, the effect of religion is very difficult to generalize because of the many causes and effects." In order to disentangle the many competing factors that could skew a result, the authors took a different track. "We look at this in a specific setting  -- the mutual fund industry -- and look at how religion can affect agent (manager) behavior in that setting," says Sulaeman. The mutual fund industry is "exceptionally competitive" note the authors, as managers strive to beat various benchmarks and each other. They will, therefore, employ various strategies to maximize performance.

Local values or market demand?

A competitive setting is an optimal setting because it can more accurately identify excessive risk-taking behavior. The authors analyzed a large sample of 1,621 unique growth and aggressive growth equity mutual funds from 1988 to 2008. Sulaeman explains, "It is not obvious that you will get rewarded by taking on risk, however. In spite of taking excessive risk, a manager may not obtain additional return. That is indeed what we observe." Additionally, fund managers in more Catholic areas take on more idiosyncratic risk but this does not improve their fund returns. Their fund return is not significantly different from funds in more Protestant areas. Sulaeman adds that excessive risk taking may have negative implications for fund investors.

Sulaeman says that the main result in their study may be due to two potential stories. One story refers to whether risk orientation is driven by local investor expectations. If the local investors in an area prefer more risk, then the managers may accommodate. Another tale revolves around whether managers' own values (for which their religion can serve as a proxy) affect their decision making.

The authors attempt to answer the question: is risk-taking orientation based on market demand (local expectations) or values of the manager? To answer this question, the study examined where a fund manager went to university as a potential proxy of values orientation. If the manager went to school in a more Catholic area, they tended to take more risk, and the opposite if they went to a school in a more Protestant area. The authors looked at managers whose universities were further away from the location of the funds they managed to provide a clean test. This indicates that the religion effect “is at least partly driven by social values, their beliefs." One twist is that when a fund does more marketing nationally, there is less reliance on the influence of local values. The more national in scope a fund is, local values drive results less.

Religion and style

Another distinctive finding about risk emerged in the study.  Catholic managers were bigger risk-takers than Protestants, displaying tournament-like behavior. Fund managers are compensated by assets under management. Their compensation or reward looks like a tournament. "For managers at the top tiers, it's winners take all," describes Sulaeman, "If your fund places at number 32, the rewards are not much different than if you are in 200th place. So it behooves you as a manager to take on more risk to place higher in the rankings." On this yardstick, Catholics took more risks than Protestants. Losing fund managers of the Catholic persuasion at mid-year were found to seek more risk in the second half of the year. If their fund's performance placed in lower rankings by mid-year, they racheted up risk to try to make up lost ground.

Another area where Catholics were observed to take more risks is in their selection of industries within a portfolio, or concentration risk. Catholics concentrated their holdings in fewer industries. When a fund is more concentrated in fewer industries, it is less diversified. In regard to risk-taking behavior, rather than seeking risk through individual stock picks, risk was observed at the portfolio level, the study found.

This is a first attempt to consider whether local values, ie., culture or religion, impact the behavior of the mutual fund and the managers that drive their performance. Earlier mutual fund studies have focused on the advantages of the mutual fund's location relative to its stock holdings and the influences of a large city. This study reveals a new twist in the innerworkings of the mutual fund portfolio— that risk, reward and values may have a new calculus.

The paper "Local Religious Beliefs and Mutual Fund Risk-Taking Behaviors" by Johan Sulaeman of Southern Methodist University's Cox School of Business, Tao Shu of University of Georgia, and P. Eric Yeung of University of Georgia and Cornell University was recently published in Management Science (October 2012).  

Written by Jennifer Warren.

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