Information footholds: Isolating local presence as a factor in analyst performance and trading

I compare the performance of buy/hold/sell recommendations from foreign, local, and expatriate (foreigners with local operations) analysts in an emerging market. Location appears to be important: expatriate analysts significantly outperform foreign analysts. Expatriates also significantly outperform locals, implying that other factors such as global resources also play a role, and a variety of controls for the characteristics of the recommending firm does not alter findings. Trading based on expatriate recommendations generates significantly positive risk-adjusted returns. Furthermore, foreign and local institutional investors appear to trade on the superior information of expatriate analysts, even when it contradicts their own information.     

Do a firm's equity returns reflect the risk of its pension plan?

This paper examines the empirical question of whether systematic equity risk of US firms as measured by beta from the capital asset pricing model reflects the risk of their pension plans. There are a number of reasons to suspect that it might not. Chief among them is the opaque set of accounting rules used to report pension assets, liabilities, and expenses. Pension plan assets and liabilities are off-balance sheet and are often viewed as segregated from the rest of the firm, with its own trustees. Pension accounting rules are complicated. Furthermore, the role of the Pension Benefit Guaranty Corporation clouds the real relation between pension plan risk and firm equity risk. The empirical findings in this paper are consistent with the hypothesis that equity risk does reflect the risk of the firm's pension plan despite arcane accounting rules for pensions. This finding is consistent with informational efficiency of the capital markets. It also has implications for corporate finance practice in the determination of the cost of capital for capital budgeting. Standard procedure uses de-leveraged equity return betas to infer the cost of capital for operating assets. But the de-leveraged betas are not adjusted for the risk of the pension assets and liabilities. Failure to make this adjustment typically biases upward estimates of the discount rate for capital budgeting. The magnitude of the bias is shown here to be large for a number of well-known US companies. This bias can result in positive net present value projects being rejected.     

Dumb money: Mutual fund flows and the cross-section of stock returns

We use mutual fund flows as a measure of individual investor sentiment for different stocks, and find that high sentiment predicts low future returns. Fund flows are dumb money–by reallocating across different mutual funds, retail investors reduce their wealth in the long run. This dumb money effect is related to the value effect: high sentiment stocks tend to be growth stocks. High sentiment also is associated with high corporate issuance, interpretable as companies increasing the supply of shares in response to investor demand.     

Winners in the spotlight: Media coverage of fund holdings as a driver of flows

We show that media coverage of mutual fund holdings affects how investors allocate money across funds. Fund holdings with high past returns attract extra flows, but only if these stocks were recently featured in the media. In contrast, holdings that were not covered in major newspapers do not affect flows. We present evidence that media coverage tends to contribute to investors? chasing of past returns rather than facilitate the processing of useful information in fund portfolios. Our evidence suggests that media coverage can exacerbate investor biases and that it is the primary mechanism that makes fund window dressing effective.     

Real effects of stock underpricing

This paper provides evidence for a causal effect of equity prices on corporate investment and employment. We use fire sales by distressed equity funds during the 2007–2009 financial crisis to identify substantial exogenous underpricing. Firms whose stocks are most underpriced have considerably lower investment and employment than industry peers not subject to any fire sale discount. The causal effect of underpricing on investment is found to be largely concentrated on the most financially constrained firms.     

Selling winners, holding losers: Effect on fund flows and survival of disposition-prone mutual funds

Recent studies suggest that presence of a disposition effect in a large subset of investors can create stock mispricings, which has serious implications for market efficiency. We examine whether US equity mutual funds are disposition-prone, how that effect influences performance, investor flows and fund survival, and whether the disposition orientation of mutual funds affects stock prices in a sustained manner.We find that about 30% of all funds exhibit some degree of disposition behavior and that such funds underperform funds that are not disposition-prone by 4-6% per year. Moreover, after controlling for performance, tax overhang and other factors that potentially affect flows, disposition-prone funds attract significantly smaller flows than other funds. The results suggest that mutual fund investors are smart enough to minimize investment in disposition-prone funds. Consequently, disposition-prone funds have significantly higher rates of failure than other funds, thereby reducing the impact of such trading behavior on security prices.     

21 years of international M&As and joint ventures by Italian medium-sized listed firms: Value creation or value destruction?

This study provides evidence of the value creation of different equity entry modes in a sample of international investments performed by all Italian medium-sized listed firms in the period 1986-2006. Our research shows a positive and significant market reaction to announcements of internationalization strategies. The results are largely affected by high-equity entry modes carried out in advanced economies. Low-equity entry modes and international operations performed in emerging countries show no significant market reaction. We also find that the relative size of the deal, the firm age, the country risk, and the evolution of information disclosure regulation, matter in explaining the outcomes.     

Business ties and proxy voting by mutual funds

The magnitude of mutual funds’ business ties with their portfolio firms is documented and is linked to funds’ proxy votes at specific firms and to overall voting practices. Aggregate votes at the fund family level indicate a positive relation between business ties and the propensity to vote with management. Votes at specific firms, however, reveal that funds are no more likely to vote with management of client firms than of non-clients. Because the votes took place when funds knew their votes would be publicly scrutinized, fund families with a larger client base may have adopted voting policies that led to less frequent opposition to management at all firms.     

Mutual fund trades and the value of contradictory private information

We investigate the performance of mutual funds that trade using private information. These funds are uniquely identified from a set of 2730 funds with 44,315 fund-periods between 1994 and 2005. We compare the alignment of fund trades with brokers’ recommendations, which we regard as “public information” in the universe of informed and uninformed mutual funds. Funds that systematically trade counter to the public information form a homogenous subset of the privately informed funds. By using private information that contradicts the public information, these funds exhibit a superior average performance. After we control for serial correlation in fund returns, we assess this advantage as being an economically significant 1.7% per annum. We also show empirically that smaller funds are better able to capture the benefit of private information.     

Are there too many safe securities? Securitization and the incentives for information production

We present a model that helps explain several past collapses of securitization markets. Originators issue too many informationally insensitive securities in good times, blunting investor incentives to become informed. The resulting endogenous scarcity of informed investors exacerbates primary market collapses in bad times. Inefficiency arises because informed investors are a public good from the perspective of originators. All originators benefit from the presence of additional informed investors in bad times, but each originator minimizes his reliance on costly informed capital in good times by issuing safe securities. Our model suggests regulations that limit the issuance of safe securities in good times.     

The liquidity risk of liquid hedge funds

This paper evaluates hedge funds that grant favorable redemption terms to investors. Within this group of purportedly liquid funds, high net inflow funds subsequently outperform low net inflow funds by 4.79% per year after adjusting for risk. The return impact of fund flows is stronger when funds embrace liquidity risk, when market liquidity is low, and when funding liquidity, as measured by the Treasury-Eurodollar spread, aggregate hedge fund flows, and prime broker stock returns, is tight. In keeping with an agency explanation, funds with strong incentives to raise capital, low manager option deltas, and no manager capital co-invested are more likely to take on excessive liquidity risk. These results resonate with the theory of funding liquidity by Brunnermeier and Pedersen (2009).     

Hedge funds,managerial skill,and macroeconomic variables

This paper evaluates hedge fund performance through portfolio strategies that incorporate predictability based on macroeconomic variables. Incorporating predictability substantially improves out-of-sample performance for the entire universe of hedge funds as well as for various investment styles. While we also allow for predictability in fund risk loadings and benchmark returns, the major source of investment profitability is predictability in managerial skills. In particular, long-only strategies that incorporate predictability in managerial skills outperform their Fung and Hsieh (2004) benchmarks by over 17% per year. The economic value of predictability obtains for different rebalancing horizons and alternative benchmark models. It is also robust to adjustments for backfill bias, incubation bias, illiquidity, fund termination, and style composition.     

The home-institution bias

We document a new investor preference we call the home-institution bias. Whereas the home-asset bias is a preference for domestic assets, the home-institution bias is a preference for domestic financial institutions. Our data come from Sweden’s government-mandated retirement system. In cross-fund regressions, we find that funds offered by Swedish institutions received around 10 times more money than similar funds offered by foreign institutions. We show that this preference for home institutions is distinct from the home-asset preference, is not driven by information asymmetries, and is consistent with an underlying preference by individuals to deal with the familiar. Cross-individual regressions also support a behavioral explanation because the home-institution bias is strongest among financially-unsophisticated and provincial investors.     

The wisdom of crowds: Mutual fund investors’ aggregate asset allocation decisions

We find that the aggregate asset allocation decisions of US mutual fund investors depend on economic conditions. Both anticipated economic downturns and periods of turmoil lead investors to direct flow away from risky equity funds and towards lower-risk money market funds. These patterns are markedly stronger for investors in low cost and low turnover funds relative to investors in high cost and high turnover funds, consistent with sophisticated investors being more sensitive to changing conditions. Benchmarked against a buy-and-hold strategy, these asset allocation strategies reduce risk without degrading the risk-return trade-off. Our evidence suggests that individual investors, often dismissed as noise traders, collectively react to economic signals in a sensible manner when determining asset allocations.     

Caught on tape: Institutional trading,stock returns,and earnings announcements

Many questions about institutional trading can only be answered if one tracks high-frequency changes in institutional ownership. In the United States, however, institutions are only required to report their ownership quarterly in 13-F filings. We infer daily institutional trading behavior from the “tape”, the Transactions and Quotes database of the New York Stock Exchange, using a sophisticated method that best predicts quarterly 13-F data from trades of different sizes. We find that daily institutional trades are highly persistent and respond positively to recent daily returns but negatively to longer-term past daily returns. Institutional trades, particularly sells, appear to generate short-term losses—possibly reflecting institutional demand for liquidity—but longer-term profits. One source of these profits is that institutions anticipate both earnings surprises and post-earnings announcement drift. These results are different from those obtained using a standard size cutoff rule for institutional trades.     

Commonalities in investment strategy and the determinants of performance in mutual fund mergers

This paper examines the determinants of cross-sectional variation in post-merger mutual fund performance. Mergers between funds with similar management objectives, as reflected by average portfolio book-to-market ratio, price–earnings ratio, beta and market capitalization values, outperform mergers between funds with dissimilar strategies. This superior performance transcends lower portfolio rebalancing costs which might be realized between merging funds which hold more assets in common. These results suggest that mutual fund mergers create collaborative benefits between funds with similar strategies. We also examine if fund governance structures influence the fund pairing process, testing if stronger fund oversight mitigates pairing mismatches. We find that less independent boards of trustees and boards with higher compensation are related to greater strategic mismatches between funds. These results suggest that more entrenched boards are more tolerant of fund mismatches which benefit the investment company, yet are not in investor’s best interests.     

When active fund managers deviate from their peers: Implications for fund performance

This paper proposes that the extent to which mutual fund managers’ beliefs deviate from the ex ante unobservable representative beliefs of their peers contains information about their skill. A new measure based on portfolio allocations, peer deviation, is used to capture a fund manager’s divergence from the contemporaneously unobservable beliefs of her peers. The portfolio based on representative beliefs of a group of managers investing in similar assets outperforms passive benchmarks, indicating that they reflect informed beliefs. Fund managers who simultaneously arrive at portfolio selections which, in hindsight, are close to those implied by representative beliefs possess ex ante more skill and exhibit future outperformance. Copycat strategies replicating lagged portfolio holdings implied by representative beliefs outperform the actual portfolio holdings of funds that deviate most, but the outperformance dissipates after two quarters.