Your mutual fund may have a political bias — and that could cost you

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You've probably heard the saying "Birds of a feather flock together."

But you probably never thought that could apply to the mutual fund you're invested in due to political bias.

Yet that is exactly what research from Dr. Yaoyi Xi, assistant professor of finance at San Diego State University's Fowler College of Business, and Dr. M. Babajide Wintoki, associate professor of finance at the University of Kansas School of Business, found.

The researchers set out to evaluate whether mutual fund managers tend to put more money into companies that are led by executives that share their political ideologies or party affiliations.

And the answer to that question, in soon to be published research, is yes.

"There is a consistent pattern that fund managers are likely to invest more in firms with leadership that have ideology that's similar to theirs," Xi said.

The research looked at the managers of 1,298 actively managed mutual funds, as well as executives of 16,655 companies.

They then compared how those individuals donated to political campaigns from 1990 through 2016, based on data from the Center for Responsive Politics. That data was used to determine the fund managers' and executives' political leanings based on their net donations.

In comparing the data, the researchers found that fund managers who leaned Republican were more highly allocated toward companies that veered the same way — about 8% higher in the average share of total net assets — compared to Democratic-leaning fund managers.

Meanwhile, Republican-leaning fund managers invested 3% less of their total net assets in Democrat-oriented companies compared to Democratic-leaning fund managers.

Admittedly, not all fund managers have a political bias. But when they do, those leanings can be expensive, the research found.

"Mutual funds with higher levels of partisan bias do not outperform those with less bias, and may even suffer from slightly worse fund performance," the research said.

That can also be costly for individual investors, according to the research.

"Funds with more partisan bias perform slightly worse than those with less bias, and have significantly inflated fund idiosyncratic risks," the research said.

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There are multiple reasons these leanings can crop up.

One is social psychology. That is, people tend to have positive views of individuals with similar beliefs to their own.

Fund managers and company executives who have similar political views are also more likely to interact with each other, through social clubs and other channels, the research said. They also are likely to live in the same geographic areas.

Consequently, individual investors need to beware when choosing between actively managed funds and index funds.

"We just want to raise awareness that actively managed fund have a lot more decision making as to what goes into the portfolio that's swayed by individual managers," Wintoki said. "Individuals have preferences, life experiences, and one of those preferences that may affect their decision making is partisan bias."

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