Noise - Chapter 14
Sources Of Noise: Private Relationships
Briefly: Private Relationships
Noise. The state of your private relationships is a source of noise that will affect your professional life.
Depletion. Disturbances in your private relationships will deplete your physical and emotional resources.
Error. You become more prone to cognitive bias and decision error when your resources are depleted.
There is a line that is too readily drawn between professional and personal life, keeping the one supposedly separate from the other. This is a popular but false distinction because the fact that you are common to both domains means that they are not separate, there is a large degree of intersection between the two. The one has a bearing on the other.
Even if you expend heroic amounts of energy trying to keep them separate, you will carry at least some of your experience from the one domain into the other. If you’ve had a tough day at the office, it is highly probable that your work preoccupations will leak into your domestic relationships in some way, even if it is in the form of your mental/emotional absence. The same holds true in reverse: it is very hard to give your full and undivided attention to your work if you have difficulties on the domestic front.
Many fund managers, when they are at the peak of their powers, where experience is still rising but mental agility has not yet started to wane, are faced with major challenges in their private relationships. It’s the natural order of things that a fund manager in mid-career will probably be dealing with young children or teenagers in the home, as well as ageing or infirm parents. These relationships will demand a chunk of your attention, and that’s if things are going well. Those who are less lucky will be faced with marital separation or divorce, or the death of a family member or a friend. Your private relationships are a source of considerable noise: they affect you physically, emotionally, and mentally.
Impact
Two researchers at the University of Washington Medical School investigated the impact that major life events have on one’s physical health. They concluded that the human body does not like sudden changes, even supposedly positive changes, and they developed a life-change index that predicted the likelihood of physical illness in the year following major life events.
Nine of the top 15 life events out of a total of 43 in the index relate specifically to changes in your personal relationships. As you might expect, events that are clearly negative, such as the death of a spouse and divorce, receive high weightings in the index. Perhaps surprisingly, apparently positive events, such as marriage and the gain of a new family member, are in the top one-third of weightings. Changes in the state of your private relationships is clearly a source of noise, given that such changes are predictive of physical illness.
Changes in your private relationships also absorb some of your emotional energy and they will divert some of your scarce cognitive resources away from the pursuit of alpha. An increase in noise from these changes sets off a chain reaction that results in you becoming more prone to cognitive biases with their attendant decision errors, for the very reason that depletion of cognitive resources causes you to take mental shortcuts while attempting to deal with complexity and uncertainty in the markets.
Red Flag
Professional allocators understand that a major upheaval in a fund manager’s personal life will affect how they perform in their professional life. They make it their business to identify ways in which a fund manager may be distracted. A common red flag for professional allocators in their due diligence process is whether the manager of a fund is involved in divorce proceedings, something that is easy for them to discover from a quick search of court records.
Paul Tudor Jones, founder of Tudor Investment Corporation, said on a panel discussion at the University of Virginia in 2013 that one of his rules as an allocator to other fund managers is that “...if I find out that manager is going through a divorce, redeem immediately, because the emotional distraction that comes from divorce is so overwhelming. The idea that you could think straight for sixty seconds and be able to make a rational decision is impossible, particularly when there are kids involved.”
Here are two eerily similar examples of prominent hedge fund managers whose marital difficulties corresponded with a decline in investment performance.
Example: Greenlight Capital
The founder of Greenlight, David Einhorn, has established an excellent track record as a value-oriented long-short equity manager, delivering 15% annualised returns from inception in May 1996 to the end of 2017.
In early 2017, the New York Post ran an article that indicated that Einhorn had separated from his wife of 24 years. The separation coincided with a period in which Greenlight underperformed the equity market, as well as its own historical rates of return. In calendar 2016 Greenlight returned 8% (which was a 4% underperformance of the S&P 500), and in calendar 2017 it returned 2% (a 20% underperformance).
Example: Pershing Square
Bill Ackman, founder of Pershing Square, is perhaps best known for his losing long position in Valeant Pharmaceuticals, and to a lesser extent, his losing short position in Herbalife. Despite some poor investment calls, Pershing Square has delivered returns of 14% a year from 2004 to the end of 2017.
An article published in the New York Post in early 2017, a month before the Einhorn article, indicated that Ackman and his wife of 25 years had separated. This came in the midst of a three-year period of severe underperformance for Ackman’s firm, relative to the broader equity market and the firm’s own historical rate of return. In 2015 Pershing Square lost 20% (underperforming the S&P 500 by 22%), in 2016 it lost 13% (underperforming by 25%), and in 2017 it lost 4% (underperforming by 26%).
But we need to be very cautious about inferring correlation between marital strife and alpha destruction from a sample size of 2, let alone concluding anything about causality. This small sample also coincided with a period that was tough for active managers, especially those with a value-orientation. Luckily, we have some research that uses a larger sample size and a longer time window.
Researchers from the University of Florida investigated their hypothesis that significant life events, specifically marriage and divorce, detract from fund managers’ attention, and therefore impact negatively on their investment results. They examined the impact of hedge fund managers’ marriage or divorce on their investment performance using publicly available, court-reported data from 1994 to 2012, which included 98 marriages and 76 divorces, along with multiple hedge fund performance databases. They found that hedge fund managers significantly underperformed during the six months around marriage and divorce, and that their underperformance persisted for two years after the marital event. The conclusion offered by this research confirms the anecdotal evidence: noise that arises from your private relationships is a threat to your ability to outperform.
Changes to your private relationships are inevitable. Even low-impact life events, such as taking a vacation or the approach of Christmas, appear on the life-change index. Events that involve people in your private life are practically unavoidable, but that does not mean that you need to be a passive victim of these events. To use the well-worn poker-as-life analogy, you may be dealt a poor hand of cards from time to time, but you get to choose how you play those cards.
How you choose to deal with the event is just as important as the event itself. The meaning that you assign to the event will either amplify and prolong the effects of the event, or it will mitigate the negative consequences of the event.
You can manage the noise that inevitably arises from private relationships, so that even highly stressful changes in those relationships do not unnecessarily impair your ability to attend to those relationships and to keep doing your job. Effective noise management does not mean you won’t take knocks, it just means that you are able to regain equilibrium. The faster that you regain your centre, the better you will do in the markets and in your relationships.
Every active fund manager will agree that you live and die by your investment performance. Many of these fund managers understand that your ability to stay in the game is also dependent on a range of professional relationships, such as your your boss and your clients. A smaller proportion behaves as if they understand that their private relationships affect their ability to deliver investment performance.
Work-life balance is usually measured in units of time, which means that it’s not really attainable for many because the fund management industry is just too competitive and demanding. A better way of looking at the intersection of professional and private domains is to aim for work-life resilience, where through effective noise management and conscious application of attention to relationships, your private life and your working life feed each other. Going on a regular date with your spouse might even be a key ingredient in your ability to outperform your competitors.
References
Holmes, T.H. & Rahe, T.H. (1967) ‘The social readjustment rating scale’, Journal of Psychosomatic Research 11.213.
Article in Business Insider on 23 May 2013 by Julie La Roche: ‘Hedge fund legend: if one of my managers is getting divorced, I’ll pull my money out.’
Greenlight Capital, fourth quarter newsletter, 2017.
Article in the New York Post on 23 March 2017 by Emily Smith: ‘Hedge fund billionaire David Einhorn heading for divorce.’
Pershing Square, London Investor Meeting presentation, 29 January 2018.
Article in the New York Post on 22 February 2017 by Emily Smith: ‘Bill Ackman’s new romance complicates ‘big money’ divorce.’
Lu, Y.; Ray, S.; Teo, M. ‘Limited attention, marital events and hedge funds’, Journal of Financial Economics (forthcoming).
Ellis, A. & Dryden, W. (1997) The practice of rational emotive behaviour therapy. New York: Springer.