Fund managers who let politics direct their portfolios shouldn't get your money

By Mark Hulbert

Politically diverse fund-management teams perform better

Funds with politically diverse management teams show both ideological and cognitive flexibility.

Political polarization has become so extreme, we now see what we want to see when analyzing economic data. Democrats believe that the U.S. economy is in much better shape than Republicans do. Just the opposite was the case when Donald Trump was president.

Consider the University of Michigan's Index of Consumer Sentiment (ICS). Among Democrats this index currently stands at 101.7, almost double the 56.3 reading for Republicans. It was almost precisely the opposite four years ago at the comparable stage of the 2020 presidential election campaign: The ICS among Republicans then stood at 111.2, versus 67.5 among Democrats.

The relative readings of these two indices switched when Joe Biden won the 2020 election, as you can see in the chart below.

There's a growing divide between Republican and Democrat financial advisers.

Not surprisingly, political affiliation is correlated with our investment decisions as well. Currently, Democrats on average have significantly higher equity-exposure levels and invest in riskier stocks than Republicans. Just the opposite was the case when Donald Trump was President.

This lack of objectivity isn't just prevalent among individual retail investors. Financial advisers and mutual-fund managers also are guilty of partisanship masquerading as objective economic and investment analysis. In addition, according to recent research, Republican advisers increasingly attract only Republican investors as clients, and vice versa. One study found that there's been a growing divide between the client portfolios of Republican and Democrat advisers.

Investors' typical response when being presented these data on the correlation between political affiliation and portfolio composition is to conclude that the economy is not in as good shape as the Democrats currently believe, but also not in as terrible shape as the Republicans assert. But this "truth is somewhere in the middle" response is only somewhat helpful.

That's because the average of two rigid extremes is still rigid. A flexible approach is more likely to detect subtle shifts in the economic and political landscape. In fact, a recent study found that, in response to the bear market that accompanied the onset of the COVID-19 pandemic in early 2020, equity mutual funds performed better, on average, when managed by teams that included both Democratic and Republican members - better than mutual funds managed by either Republican-only or Democratic-only management teams.

The study was conducted by Blair Vorsatz as part of his Ph.D. dissertation at the University of Chicago; he currently is a portfolio strategy analyst at investment manager Dodge & Cox. Vorsatz found that funds with politically diverse management teams fared better because they were both ideologically and cognitively more flexible. Ideological flexibility is "the absence of ideological preferences that constrain portfolio choice." By "cognitive flexibility," he was referring to the ability to "to adapt to novel or changing environments and to switch between modes of thinking."

The investment implication of this research is the importance of seeking out a range of opinions and perspectives. One approach would be to become part of an investment club whose members are from both political parties. Another would be to subscribe to investment newsletters whose editors represent a diversity of views, both political and economic.

Regardless, don't make your investment decisions from within the echo chamber in which you see and hear only what you want to see and hear.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

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-Mark Hulbert

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