Poker-Playing Hedge Fund Managers Have an Edge

(Bloomberg Opinion) -- Do poker players make good hedge fund managers? On one hand, there’s skill overlap. Both activities demand aggressiveness, accurate calculations under pressure, keen behavioral insight and shrewd risk-taking. On the other hand, poker seems like a risk-seeking activity, suggesting reckless and overconfident managers. Poker requires deception and gamblers are often considered untrustworthy. Also, time spent learning and playing poker is time taken away from investing.

Academics Yan Lu, Sandra Mortal and Sugata Ray try to answer the question  in a new paper titled “Hedge Fund Hold’em.” This is part of an emerging academic interest in correlating recreational activity to business and investing success. The most famous paper in the field found that hedge fund managers who own powerful sports cars have the same average returns as managers who own everyday cars or take the bus, but take more risk, so they have lower Sharpe ratios and less alpha. Studies have shown that chief executive officers who play a lot of golf and win awards tend to deliver lower performance, presumably due to the distraction from business.

You can dismiss these studies as click bait, especially given non-academic-sounding titles such as “Hedge Fund Hold’em” or “Fore! An Analysis of CEO Shirking.” While statistically significant, the effects found are not of much practical use. If you knew nothing about a manager except what car she drove, or whether his favorite game was poker, chess, bridge or Chutes and Ladders you might do slightly better by using that information. But no sensible person gives money to a manager without knowing more, and conditional on track record, strategy, intelligence, honesty, processes, team and so on, the car and games likely don’t matter.

The better studies have a serious point to make. If personal characteristics of top decision makers such as their personalities, attitudes toward risk or game skills have measurable effects, however small, on their performance, then this is an important field of study. Presumably more comprehensive research could tell us much more about how to select and train people charged with making high-stakes decisions. But if personal characteristics don’t matter, perhaps because decision outcomes at the top are random, or because decisions are made through objective processes rather than personality, or top leaders are figureheads, then there’s no point delving deeper into the relation between personality and performance.

The headline result of the latest paper is that hedge fund managers who have won poker tournaments have more alpha, representing an additional 4.2 percentage points in returns per year versus 2.8 percentage points for other managers, through a combination of higher average returns and lower average risk.

If the paper had stopped there it would be a random factoid too thin to be relied upon. But the authors go on to control exhaustively for possible confounding factors and to eliminate alternative explanations. Funds of poker playing managers do not differ significantly on other relevant dimensions from funds of non-poker-playing managers. Past poker success predicts future fund returns, and past fund returns predict future poker success. More success in bigger tournaments is correlated with more hedge fund success than less-successful poker-playing managers.

Poker skill only seems to help in fundamental strategies in which the manager is making partly subjective judgments about unique situations, as George Soros does in real life or Bobby Axelrod does on the fictional Showtime television series “Billions.” Technical, quantitative and systematic managers who play poker do somewhat better than their non-poker-playing counterparts, but the difference is not statistically significant at conventional levels. This strengthens the case that it is poker skill that helps the hedge fund returns rather than some correlated factor.

Funds get more money after a manager wins a poker tournament, especially big wins in tournaments with extensive media coverage. Unfortunately, fund performance declines with the new flows, apparently because the manager’s best ideas are already exploited to capacity, so the money is put to work in conventional hedge fund trades.

There are data problems. The authors are only able to track performance in public poker tournaments, and for funds that report to public databases. There are issues matching names. They don’t know how many poker tournaments a manager entered. However, the fact that they find such strong results even with these problems is impressive.

The important takeaway is we need more systematic research on behavioral characteristics and skills of top decision makers. Maybe then we can train and select a better class of leaders, not just in fields like poker and trading where performance can be measured objectively, but in business and politics as well.

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Aaron Brown is a former Managing Director and Head of Financial Market Research at AQR Capital Management. He is the author of "The Poker Face of Wall Street." He may have a stake in the areas he writes about.

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