Fire Your Hedge Fund, Hire Your Congressman

Yahoo! News | May 27, 2011
By Randall W. Forsyth

House members outperform the stock market, though not as much as Senators, study finds. The ultimate insiders?

The Holy Grail of investing has been found: get elected to the U.S. Congress.

According to an academic study published Wednesday in the journal "Business and Politics," members of the House of Representatives outperform the average stock-market investor by 55 basis points a month, or 0.55 percentage points, according to the Washington Times, which brought it to my attention. Extrapolated over a full year, that figures to an extra 6.8% per annum after compounding better than hedge-fund superstars.

To add just 68 basis points, let alone 680 basis points, consistently makes you the equivalent of a lifetime .300 hitter in the Big Leagues. Most money managers trail the market, especially after expenses are deducted. After all Wall Street is not Lake Wobegone; not all managers can be above average.

To give an indication of what House members' outperformance is worth, investing at the stock market's long-term total return of 10% would mean $10,000 would grow to $25,937 in 10 years. But with their special investment acumen, their 16.8% annual returns would leave them with $47,253 in 10 years.

The authors of the study Alan J. Ziobrowski of Georgia State University, James W. Boyd of Lindenwood University, Ping Cheng of Florida Atlantic University and Brigitte J. Ziobrowski of August State University found that House members generated those excess returns in the stock market during 1985 to 2001, great bull market years, and not by accident.

"We find strong evidence that Members of the House have some type of non-public information which they use for personal gain," the authors concluded.

But, they add, House members' excess equity returns trail those of Senators during the same time period, according to their previous study of investment return of the upper house some 85 basis points a month. Annualized, that figures to 10.7% per year after compounding.

The smaller returns of Congresspersons compared to Senators "are due presumably to less influence and power held by the individual Members." It's simple math; there are 435 House Members compared to just 100 Senators, so power is more concentrated in the upper house.

Let me translate from the proper academic usage. Members of Congress used inside information gleaned from their positions of power to enrich themselves in the stock market. The more powerful Senators enriched themselves more than members of the House. Like Captain Renault in Casablanca, I'm shocked, shocked!

Stock trading was confined to a relatively small minority of Reps, never more than 27% of the total, and the median number of transactions was between three and four. But the median number of trades is much higher, between 8 and 21 per year, indicating a relatively few Congresspersons are fairly active traders, the study found. The excess returns were spread out among the larger group, so the buy-and-hold types did as well as the traders.

You'd think that Republicans would have the better investment results since the GOP is seen as the party of Wall Street. You'd be wrong. The Democrats did four times as well as the Republicans, generating excess returns of 73 basis points per months versus 18 basis points.

The study's authors' interpretation: during the period covered by the study, Democrats controlled the House for 10 of 17 years. "Furthermore, Democrats were deeply entrenched in the leadership of the House for decades prior to the study. Thus when Republicans finally took control in 1995, they arguably had far less experience at handling the reins of power and may therefore have been unable to immediately enjoy all its perquisites," the academics write.

However, they continue, members of the House were less likely to hold common stocks than Senators and traded less. That's because Senators on average are far wealthier.

The data strongly imply the information and influence House members and especially Senators accrue is translated into personal gain in the stock market.

The professors recommend Congressional committees be studied for "abnormal" stock returns and indications that members may favor shares of companies in industries they oversee. In addition, they suggest examining any connection between campaign contributions, stock purchases and abnormal returns. Moreover, they say the same studies should be extended to the Executive and Judicial branches.

Moreover, they make the estimably logical proposal that the same reporting requirements imposed on corporate insiders be placed on members of Congress. After all, being on Capitol Hill makes one an ultimate insider.