Portfolio manager home‐country culture and mutual fund risk‐taking

• Author: Wei Jiao
• Published date: 01 September 2020
• Date: 01 September 2020
• DOI: http://doi.org/10.1111/fima.12265

DOI: 10.1111/fima.12265

ORIGINAL ARTICLE

Portfolio manager home-country culture and

mutual fund risk-taking

Wei Jiao

University of Wisconsin–Green Bay,Green Bay,

Wisconsin

Correspondence

WeiJiao, Cofrin School of Business at the

Universityof Wisconsin–Green Bay, 2420 Nicolet

Drive,Green Bay, WI 54311.

Email:jiaow@uwgb.edu

Abstract

I find that home-country culture affects portfolio managers’ invest-

ment risk-taking and performance. I focus on security value, which

measures the degree to which people in a country assign importance

to security, safety, and stability. Funds managed by managers from

countrieswith higher security value exhibit lower fund return volatil-

ity,trade less frequently, and follow benchmarks more closely. These

funds also tend to avoid lottery-type stocks and hence perform

significantly better. However, the impact of home-country security

value decays as managers spend more time away from their home

countries.

1INTRODUCTION

Should investors pay attention to their portfolio managers’ home-country culture when investing with them? Values

and beliefs rooted in home-country culture are known to affect individuals’ behavior (see, e.g., Chui, Titman, & Wei,

2010; Fisman & Miguel, 2007; Guiso, Sapienza, & Zingales, 2006; Hofstede, 1984; Landes, 1998; Nguyen, Hagendorff,

& Eshraghi, 2017). In this study,I present evidence to show that security value—a basic human value rooted in home-

country culture—has a significant influence on portfolio managers’ investment risk-taking and performance.

Cultural values are critical motivators of behaviors and attitudes (Schwartz, 2012). The theory of basic human val-

ues by Schwartz (1992) describes the motivational goal of security value as safety, harmony, and stability of society

of relationships and of self. Portfoliomanagers in the mutual fund industry are tasked with making risky investments.

Their compensation and careers heavily depend on how they deal with investment risks. The inclination to prioritize

security,safety, and stability rooted in managers’ home-country culture may induce them to take low investment risks

and pursue relatively passive investment strategies. As a result, we may expectmutual funds managed by managers

from countries in which people generally assign more importance to security,safety, and stability to exhibit lower fund

return volatility and idiosyncratic volatility,trade less frequently, and follow their benchmarks more closely than their

peers.

Meanwhile, portfolio managers’ home-country security value may also affect fund performance. Previous research

documents that assets with low volatility or low idiosyncratic volatility have high expected returns (see, e.g., Ang,

Hodrick, Xing, & Zhang, 2006, 2009; Frazzini & Pedersen, 2014; Haugen & Heins, 1975; Jordan & Riley,2015). Thus,

c

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the low fund return volatility and idiosyncratic volatility associated with managers’ home-country security value may

translate into superior fund performance. Further, trading can be hazardous to investment performance (Barber &

Odean, 2000, 2001). As a result, managers with higher home-country security value mayperform better by trading less

frequently.Finally, lottery-type stocks deliver poor performance (Bali, Cakici, & Whitelaw, 2011; Han & Kumar, 2013;

Kumar,2009). Therefore, managers who culturally value security more may tend to avoid lottery-type stock holdings,

which leads to outperformance.

In this study, I identify a portfolio manager’s home country as the one in which she receives the undergraduate

degree. I define the home country in this wayfor two reasons: First, the country where a portfolio manager first attends

college is likely the country in which she was born and raised; second, the psychology literature demonstrates the

importance of the college yearsin forming an individual’s personality traits and worldview (Izard, 1962; Plant & Telford,

1966; Yang,Harlow, Maddux, & Smaby, 2006). If we accept this observation, the culture of the country in which a port-

folio manager spends her college years is likelyto have a profound and long-lasting influence on her behavior.

Totest the impact of home-country security value on portfolio managers’ investment risk-taking and performance,

I use US international equity mutual funds—that is, funds located in the United States that are mainly invested in

global stocks. The principal reasons for selecting these funds are as follows. First, a significant percentage of port-

folio managers managing these funds are from a broad range of non-US countries. My sample includes 323 unique

managers, 24% of whom grew up in one of 14 non-US countries.1Second, most of the non-US managers in the sample

received their graduate education in the United States, and, on average,they have been in the United States for about

20 years.We might reasonably expect that they have been deeply influenced by US culture and retain little of their own

home-countryculture. Therefore, any findings pertaining to the impact of home-country culture on portfolio managers’

investmentrisk-taking in this setting are compelling. Third, the portfolio managers of these funds invest globally. Com-

pared to investing in stocks from their home countries only (e.g., US managers managing US domestic equity funds),

these managers face more complicated investment choices and higher risks. If a tendency to pursue security rooted in

their home-country culture influences their investment risk-taking, we may expect to seethe strongest effects when

these managers invest globally.

Toestablish a clean setup to test the impact of home-country security value on portfolio managers’ investment risk-

taking and performance, my analyses focus on funds with a single manager. I rely on the security value index (SVI)

constructed from the World Values Surveyto measure the degree to which people in a country attach importance to

securityvalue. My empirical results reveal a systematic and robust pattern: Funds managed by portfolio managers from

countries with higher security value exhibit significantly lower investmentrisk-taking and perform significantly better

than do funds managed by managers from countries with relatively lower security value.

Ifind that a one–standard deviation increase in portfolio managers’ SVI is associated with a 0.75% absolute decrease

in annual fund return volatility (a 4.44% decrease relative to the average annual fund return volatility) and a 0.27%

absolute decrease in annual fund return idiosyncratic volatility (a 6.59% decrease relative to the averageannual fund

return idiosyncratic volatility).

I also find that funds managed by managers from countries with higher security value trade significantly less and

follow benchmarks more closely.A one–standard deviation increase in managers’ SVI is associated with a 7.46% abso-

lute decrease in annual fund turnover ratio(an 8.59% decrease relative to the average annual fund turnover ratio) and

a 0.21% absolute decrease in fund tracking error based on monthly returns (an 11.7% decrease relative to the average

fund tracking error).

Toaddress potential endogeneity concerns, I use moderate earthquake frequency as the instrumental variable. If

people living in a country historically are more likelyto experience earthquakes with a moderate level of fatalities, they

are more likelyto adapt to earthquakes, become more resilient to dangerous surroundings, and assign less importance

1For comparison, see Kumar,Niessen-Ruenzi, and Spalt et al. (2015), who show that among the managers of US domestic equity mutual funds, 5.29% have

foreign-soundingnames and 4.50% of fund-year observations have managers with foreign-sounding names.

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to security.2Consistently,I find that moderate earthquake frequency is strongly negatively related to the SVI. And the

analyses using moderate earthquakefrequency as the instrumental variable confirm that managers with higher home-

country security value take significantly lower investmentrisks.

Furthermore, calendar time portfolio tests indicate that portfolio managers from countries with higher home-

country security value outperform those from countries with lower home-country security value. A strategy of buy-

ing funds managed by managers with top SVI and selling short funds managed by managers with bottom SVI yields

risk-adjusted returns of 4.56% per year.The analyses of funds’ equity holdings reveal that this fund performance dif-

ference is mainly driven by lottery-type stock holdings. After excludingthe lottery-type stocks from funds managed by

managers with top and bottom SVI, I no longer observe the difference in fund performance.

Finally, I investigate whether the time managers have spent in another culture affects the impact of their home-

country security value on fund investment risk-taking and performance. I find that the differences in fund return

volatility, idiosyncratic volatility, and fund performance associated with the home-country security value of non-US

managers decay as the length of time these managers havespent in the United States increases.

This paper contributes to the literature that links portfolio managers’ characteristics to mutual fund asset alloca-

tions and performance. Chevalier and Ellison (1999) examine the career concerns of managers and document that

younger managers take on less unsystematic risk and are less likely to deviate from the herd than older managers.

Coval and Moskowitz (1999, 2001) document that fund managers tend to overweight and outperform on their local

holdings. Cohen, Frazzini, and Malloy (2008) find that mutual fund managers who are connected to members of cor-

porate boards through their alumni networks place larger bets on connected corporations and perform significantly

better on these connected positions. Greenwood and Nagel (2009) show that around the peak of the technology bub-

ble, mutual funds run by youngermanagers are more heavily invested in technology stocks. Pool, Stoffman, and Yonker

(2015) show that fund managers who live near one another have similar holdings and trades, and stocks purchased

minus sold by neighboring managers deliver positive risk-adjusted returns. This study significantly extendsthe litera-

ture by showing that portfolio managers’ home-country culture affects their investmentrisk-taking and performance.

This paper also contributes to the literature examiningthe cultural effects on investment behavior. Guiso, Sapienza,

and Zingales (2008) find that lack of trust adversely affects stock market participation. Anderson, Fedenia,Hirschey,

and Skiba (2011) show that investment funds from countries characterized byhigher uncertainty avoidance behavior

display greater home bias and are less diversified in their foreign holdings. Egalitarianism—a keyc ulturaldimension—

is found to influence cross-border investment flows in Siegel, Licht, and Schwartz (2011). Shu, Sulaeman, and Yeung

(2012) find that funds located in low-Protestant or high-Catholic areas exhibit significantly higher fund return volatil-

ities. In this study, I focus on portfolio managers’ home-country culture. I rely on a unique identification strategy to

link portfolio managers to their home-country culture. I show that home-country culture significantly affects portfo-

lio managers’ investmentrisk-taking and performance even when these managers pursue professional careers outside

their home countries.

2DATA AND SUMMARY STATISTICS

In this section, I describe the data sources, define the main variables, and describe the principal characteristics of the

US international equity mutual funds in my sample.

2.1 Data and sample construction

I draw information on US international equity mutual funds from Morningstar. Morningstar reports portfolio man-

agers’ biographical information. Morningstar is also the source for fund return, portfolio holdings, and other fund

2Similarly, Bernile, Vineet, and Raghavendra(2017) find that firms led by chief executive officers (CEOs) who haveexperienced a fatal disaster without

extremelynegative consequences behave relatively aggressively, whereas firms led by CEOs who have witnessed the extreme downside of disasters behave

moreconservatively.