Financial advisors spend lots of time making sure that clients’ portfolios are diversified in terms of assets and sectors within those assets, but there’s another layer of diversification they should consider that could help maximize returns and attract more clients. They should include female money managers to their mix of asset managers, says Meredith Jones, author of the new book Women of the Street: Why Female Money Managers Generate Higher Returns (And How You Can Too).
“It is widely accepted in investing that diversification is a good thing,” writes Jones. “We diversify across managers, sectors, geographies, stock and bonds, and time frames, among other things. Wouldn’t it make sense to diversify behaviors and hormonal profiles as well?”
She tells ThinkAdvisor that “you’re not sacrificing returns and you may be actually be maximizing returns” having more female money managers.
Jones interviews a dozen money managers in her book and reviews research on the differences between male and female investors.
A 2009 study by Vanguard of 2.7 million IRA investors found that during the 2007-2008 financial crisis, accounts led by women lost 13%, while accounts led by men lost 16%; women were much less likely to sell into the stock slide, at or near market lows.
This pattern also held true for hedge funds. From January 2000 to May 2009, hedge funds owned by women gained 9.06%, compared with 5.82% for the composite hedge fund index, according to Hedge Fund Research. And more recently, the WAIHF (Women in Alternative Investments Hedge Fund Index), which Jones help to design, returned 6% from January 2007 through June 2012 while the HFRX Global Hedge Fund Index fell 1.1%.
“There is a small but growing dataset on the performance of female investors, be they individuals or women-owned or managed funds,” writes Jones. “It certainly appears that women can and do outperform in some cases meaningfully.”
At the root of this outperformance are the different ways that women money managers behave compared to men. Here are the seven primary reasons behind those differences, according to Jones:
1. Women Are Less Overconfident
“Simply put, men tend to exhibit more overconfidence than women,” writes Jones. She cites a groundbreaking study from 2001 by economists Brad Barber and Terrance Odean of 35,000 household customers of a large brokerage firm, which found that although men and women expected their portfolios to outperform the market, the men expected to outperform by a wider margin.
In the world of money management, overconfidence can lead to overconcentration in a single position and holding a position too long without taking any profits off the table, according to Jones. That “can kill returns faster than market volatility or violent sell-offs,” Jones writes.
She recalls a time when she was director of research at an investment firm and watched a male money manager pour 80% of a portfolio into one stock, then maintained the position even as the “high-dollar” stock turned into a penny trade. Most male money managers would not make the same mistake, but female money managers are even less likely to do so, according to Jones.
2. Women Take Fewer Risks Than Men — but Are Not Risk-Averse
The differences between men and women in terms of overconfidence translates into women taking fewer risks when investing. “Men are more optimistic about probabilities, while women are more pessimistic, which impacts risk decisions, but also doesn’t equate to true risk aversion,” writes Jones. In other words, women aren’t risk-averse, but tend to take less risk than men when investing because they are more pessimistic about the possible outcomes.
That pessimism, according to a study from the Zurich-based Institute of Economic Research, can actually “help boost returns and defend against losses on an individual or fund level and can help safeguard the overall markets as well,” writes Jones.
Not surprisingly, women “tend to emphasize risk reduction more than men in portfolio construction,” according to a 2001 study by Robert Olsen and Constance Cox, which Jones cites.
3. Women Trade Less Often Than Men
“Another effect of overconfidence is increased trading,” writes Jones, and more trades often mean smaller profits. More trades mean more trading costs and often higher taxes since positions held for one year or less are taxed at one’s income tax rate rather than the lower capital gains tax rate. In addition, investors who trade often tend to sell near market bottoms and buy closer to market tops — the opposite of a profitable investment strategy.