Our attitudes towards risk depend heavily on external factors, such as gender, age, and personal experiences. But according to Dietmar Fehr and Yannick Reichlin also with whom we hang out.
Almost 20 years ago, French philosopher and provocateur Alain de Botton published his analysis of how capitalism, income inequality, democracy, and the media all conspire to create status anxiety. His argument was that in our modern society we all compare ourselves to others around us. This, in turn, leads to excessive consumerism, or, as the saying goes: “to spend money we don’t have to buy things we don’t need to impress people we don’t like.”
Of course, de Botton didn’t identify a new human trait that appeared in the 21st century. He was just clever enough to give the emperor enough new clothes to write a best-selling book. We are inherently competitive, and we always compare our situation with those of our friends, family, and other people in society.
What has changed in the 21st century, however, is that we now have media that allows us to compare our situation with those of millions of people around the world. Back in the 19th and 20th centuries we didn’t have FOMO, or at least not to the same extent as we have it today.
The same goes for investors and fund managers. Thanks to modern databases and the work done by investment consultants, every fund manager today is compared to a myriad of funds around the world with similar characteristics. So what do these fund managers do when they start to feel status anxiety because their fund underperforms the peer group?
Well, we don’t know exactly, but we do know that hedge fund managers that are below their high-water mark and thus at risk of missing out on their performance fee tend to increase risk taking in their funds or shut down their funds and open a new one.
Private investors, meanwhile, simply increase their risk taking to catch up with people higher up on the flagpole than they are. The study mentioned above by Fehr and Reichlin put people into a position where they were made to believe that their wealth is among the lowest 10% to 20% of their peer group. Then they were asked to participate in risky investment decisions with different levels of risk. Just like in financial markets the investment options were designed to offer higher expected returns for higher levels of risk.
And guess what, people who were made to believe that they are among the poorest people in their peer group on average took 18% more risk in their investment decisions than people who were made to believe that they are above average in their wealth. Status anxiety triggered increased risk-taking to catch up with peers.
But there was one group of people who would increase their risk taking even more, by a whopping 34%. People who believed that luck is not in their own hands but decided by fate, omens, or other external factors were even more willing to take on risks than people who thought that they are responsible for the outcome of their actions.
So, if you own money and want to entrust it to a professional fund manager, the lesson to heed is not to give it to superstitious fund managers. They are more likely to take bigger risks since they already have their excuses ready when things go wrong. It was never their fault, always some external reason.
And if you are a fund manager yourself, be aware that status anxiety can lead you astray and tempt you to take on risks that you would not have taken had you not compared your situation to that of other funds.