Last week, hurricane Dorian caused enormous destruction in the Bahamas and the South East of the US. Especially the Bahamas were severely hit, and I hope the country and its citizens will get back on their feet soon.
With this tragedy in mind, it seems almost cynical to consider what impact hurricane Dorian might have on fund managers and their portfolios, but there is some research that looks at the impact climate disasters have on fund managers.
And this research indicates that fund managers who are located in the areas where a hurricane hits have a hard time ahead of them performance-wise. After all, fund managers are only human and experiencing a severe catastrophe like a hurricane or a tornado first-hand will create fear in everyone. This general mood of fearfulness then unconsciously influences the investment decisions of fund managers.
Last year, Gennaro Bernile from the University of Miami and his collaborators looked at the behaviour of US fund managers who manage international stock funds. If the fund manager was directly influenced by a hurricane or tornado in the US, the managers would subsequently reduce portfolio risk – despite the fact that they are managing international stocks that were unaffected by the climate disaster.
The size of this increased risk aversion of fund managers is sizeable and lasts up to three years. In the first year after the disaster struck, the volatility of the portfolio declined by 2.1% on average. In the second year, the volatility was still 1.1% below the fund volatility from before the disaster struck. The impact of this lower volatility is also lower returns. The fund performance declined by 1.7% in the first year after the disaster and 0.7% in the second year. Only in the third year did performance recover. These effects are so big, that investors might want to check if they hold funds where the portfolio manager is located in the Carolinas, Georgia or Northeast Florida – the areas were Dorian hit the US. These fund managers have a much higher chance of underperformance over the next few years simply because the managers got the shakes.
Impact of climate disasters on fund performance
Source: Bernile et al. (2018).
More recently, a study of US fund managers managing domestic stock funds by Shashwat Alok and colleagues showed that in reaction to severe climate disasters, fund managers actively reduce the portfolio weights of companies based in areas hit by the disaster. Even though most of these companies’ businesses are hardly impacted by the disaster, fund managers in the area reduce their portfolio holdings in the fund for four to six quarters. This effect apparently is so strong that investors can gain outsized returns by investing in the stocks of those companies that are most reduced by the affected fund managers. Luckily, Fortune provides a nice interactive map of the Fortune 500 headquarters and their headquarters, which allows to select candidates for stocks that might suffer from undue caution by fund managers.
Headquarters of Fortune 500 companies