Does Doubling Down Work?

Does Doubling Down Work?

November 17, 2014 Research Insights
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(Last Updated On: January 18, 2017)

Doubling Down


I demonstrate that when investment fund managers “double down” on positions that have run against them, they outperform. Specifically, I find that a portfolio formed of the U.S. equity positions that hedge fund managers add to after recent stock-level underperformance generates significant annualized risk-adjusted outperformance of between 5% and 15%. This finding is not the result of a simple reversal effect, of a fund’s best ideas (large positions), or of the general informativeness of fund trades. My results are consistent with a career risks mechanism for this phenomenon. By adding to a losing position — the opposite of window dressing — managers are making their losses particularly salient. I demonstrate in a panel regression that investment managers avoid adding to losing positions. Furthermore, managers outperform by more when they double down after greater past losses in a position. These findings suggest a position-level limits to arbitrage effect. Even when an asset decreases in price for non-fundamental reasons, some of the investment managers with the most relevant knowledge of that asset may be particularly hesitant to add to their positions because they have already suffered losses in that asset. 

Alpha Highlight: 

When you hold a stock that plummets, you have three choices:

  1. sell and get rid of itstop the losses
  2. hold and see what happens — disposition effect
  3. double down and buy more — believe there is a short-term mispricing and hope for a promising comeback

Under the pressure of career risks, mutual/hedge fund managers tend to “window-dress” before disclosing performances to clients, especially at the end of quarter/year. To “paint” a clean portfolio picture, and dress their window, managers sell those stocks with large losses, and buy stocks that have done well. Due to window-dressing pressures (which can also be due to tax efficiency or momentum signals), managers are sometimes hesitant to add more to a losing position.

In this paper, the author finds that despite these pressures, fund managers sometimes do make the tough decision and “double down.”

When fund managers “double down” on recent losing positions, those portfolios tend to outperform!

Key Findings:

  • With a sample from 1/1990 to 12/2013, the paper finds that a portfolio formed of the positions that fund managers add to after recent stock-level underperformance generates significant annualized risk-adjusted outperformance of between 5% to 15% (Table below shows the monthly performances). Double down portfolios perform best with around a 6 to 9 month holding period.

 * Note the underlined sentences define the doubling down portfolios in this paper.

2014-09-24 16_36_17-Doubling Down.pdf - Adobe Reader
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

How to explain the “doubling down” effect?

The paper then constructs a variety of control portfolios to demonstrate that the “doubling down” effect is not explained by a simple reversal effect, or by the general informativeness of fund trades. Rather, the author contributes this effect to “career risk” of fund managers. The paper measures managers’ portfolio returns over recent quarters, and compares them to returns earned by other managers. If a manager has outperformed recently versus peers, the manager is assumed to have relatively lower career risk. If a manager has underperformed recently versus peers, the manager is assumed to have relatively higher career risk. The paper finds some evidence that managers who have done well recently (lower career risk) are more likely to double down as compared with managers who have done worse recently (more career risk). These lower performing managers might be more inclined to window dress and less inclined to double down due to the career risks they face. Perversely, a manager’s recent underperformance may drive him to make more bad decisions. By contrast, a high performing manager, who is more secure in his job, may have more confidence to double down on a position that has moved against him.

To be specific:

  • By adding to a loser, fund managers usually call more attention to their decisions. So the doubling down decisions represent a clear demonstration of the information content of a fund manger’s decisions.

One potential downfall from a double down strategy  — overconfidence.

Time to double down on your losing stocks?

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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.

  • choffstein

    Took a quick skim of the paper. Any idea if there is risk of survivorship bias here? Looking into the 13F filing link provided in a footnote, it looks like it should be survivorship bias free. But if not … that could certainly be one explanation: the other managers that doubled-down went out of business.

    I also wonder how much the resulting return factor correlates to the high conviction factor. It seems that based on the screening they do, they end up with a universe of high conviction picks. And if the manager doubles down? Even higher conviction…

  • This is definitely a possibility and an outstanding point. I’m sure as the author goes down the publication path and enters the peer review buzzsaw, a lot of the questions you’re asking will have to be answered in much greater detail…

  • Eric

    How does the reconcile with the advice to sell your losers and buy your winners (the opposite of what most people do)?

  • It doesn’t.

    We know momentum is robust…so that puts extra pressure on these authors to show how their specific sample bucks stacks of research pointing in the opposite direction.

    My instinct thinks this is related to the very unique sample the authors are examining (which is different than the broader universe of securities where momentum works well).

    Who knows…