A new study says members of Congress make lousy stockpickers overall, with one key exception: when they invest in local businesses

By Ben Steverman

U.S. senators and representatives know their districts, and that knowledge can be profitable, according to a new study. Even as members of Congress fail to beat the stock market overall, they excel when buying and selling stocks of local companies.

“They seem to know something other people don’t know,” says Jens Hainmueller, a political science professor at the Massachusetts Institute of Technology. Using annual financial disclosure forms, Hainmueller and Yale University post-doctoral fellow Andrew Eggers reconstructed the portfolios of the 422 members of Congress who held individual stocks from 2004 to 2008.

They discovered that when congresspeople bought the stocks of public companies headquartered in their districts, they outperformed the market by more than 4 percent per year. Overall, their record was poor; a portfolio of all their stocks underperformed the market by 2 percent to 3 percent per year. Compounded over the five years of the study, that small difference was statistically significant, the authors say. In all, the study analyzed 48,309 transactions in 2,581 different stocks listed on the New York Stock Exchange, Nasdaq, or the American Stock Exchange.

Influence That Helps

The study raises troubling questions about congressional investing, says Bill Allison, editorial director at the Sunlight Foundation, which advocates for more government transparency. He notes congressmen can help out local companies by influencing tax provisions, government contracts, appropriation earmarks, and other policies. “When you think about what members of Congress have the most power to influence, it is companies in their district,” he says.

It is legal for a congressman to buy stock in a company that lobbies him or invest based on information learned in the halls of the Capitol. A bill to restrict such practices—the Stop Trading on Congressional Knowledge, or STOCK, Act—was introduced in the House in January 2009 by U.S. Representative Brian Baird, a Democrat from Washington State. Baird is now retiring, and his bill attracted only 10 co-sponsors and failed to get out of committee.

Disclosure of stock purchases and other investments is done on an annual basis, and many of the forms are hand-written. That makes analysis of conflicts of interest difficult, Allison says. This latest study was possible only because the Center for Responsive Politics, a nonprofit organization, transcribed the reports to convert them into digital form. Eggers and Hainmueller obtained their data from the center for free and conducted their own analysis.

The only member of Congress mentioned by name in the study is Representative Jane Harman, a California Democrat, because the size of her individual stock holdings averaged $140 million, compared with $93,000 for the median member. Harman is married to Sidney Harman, the chairman emeritus of Harman International Industries (HAR).

Not So Good at Timing

The study’s co-authors uncover some evidence that might lessen worries about corrupt investing by congresspeople. For example, “they don’t seem to have great timing with these local investments,” says Eggers, the study’s co-author. In other words, the politicans aren’t buying local stocks just before they jump or selling right before they fall. Rather, perhaps because they know first-hand the most capable management teams, they’re picking the local stocks that do well over the long term. “They seem to be able to pick winners,” Eggers says.

The study, which is still being prepared for publication, calculated not just the performance of members’ local stocks but also the performance of those public companies that lobbied member’s committees and those that indirectly contributed to their campaigns. In both of those cases, the study found those holdings perform about as well as the rest of the market.

Moreover, members of Congress don’t seem to be profiting overall from their power and connections, at least in the stock market. From the beginning of 2004 to the end of 2008, a portfolio of stocks picked by senators and representatives would have lost 30 percent of its value. By contrast, an inexpensive index fund—an investment that’s often recommended by experts—would have lost 20 percent in the period, which was marked by the financial crisis and the onset of recession.

No Fees or Trading Costs

“They do no better than the average individual investor,” Eggers says. Various groups within Congress all chose stocks poorly: Democrats and Republicans, senators and representatives, the very wealthy and relatively poorer members, and members of powerful committees. The study found little evidence that in late 2008, as Wall Street was seized by financial crisis and Congress debated a rescue package, members of Congress took advantage of the situation. In fact, the authors write, “Performance relative to the market was if anything slightly better in 2004-2006 than in 2007-2008, suggesting that on average, members of Congress did not capitalize on the unusually active role of the government in the economy during the latter period.”

Members of Congress are the latest in a long line of otherwise savvy people—including mutual fund managers—shown by academic studies to have trouble beating the market. Because Eggers’ and Hainmueller’s study did not take into account fees and trading costs, the actual performance of congressional investments was probably even worse than the study found, they note.

The 2010 election brought to Washington mnore than 100 new senators and representatives. As these freshmen members of Congress hire staff and compete for committee assignments, they might want to follow the same investing tips often aimed at their constituents: Don’t try to outsmart the market, and keep your fees low.

“If anything, this suggests they should take ‘Investing 101,'” Eggers says. “They would have done better if they’d taken widely available advice and bought a stock index fund.”

Steverman is a reporter for Bloomberg News .