Smart money
Hedge fund politics and portfolios
Luke DeVault & Richard Sias
Journal of Banking & Finance, February 2017, Pages 80–97
Abstract:
Consistent with the well-documented relation between political orientation and psychological traits, hedge funds’ political orientations are related to their portfolio decisions. Relative to politically conservative hedge funds, politically liberal hedge funds exhibit a preference for smaller stocks, less mature companies, volatile stocks, unprofitable companies, non-dividend paying companies, and lottery-type securities. Politically liberal hedge funds are also more likely to enter new positions or fully exit existing positions, and make larger adjustments to their U.S. equity market exposure. Our results suggest that psychological characteristics can influence the portfolio decisions of even those at the very top of the financial sophistication ladder.
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WSJ Category Kings - The impact of media attention on consumer and mutual fund investment decisions
Ron Kaniel & Robert Parham
Journal of Financial Economics, forthcoming
Abstract:
We exploit a novel natural experiment to establish a causal relation between media attention and consumer investment behavior, independent of the conveyed information. Our findings indicate a 31% local average increase in quarterly capital flows into mutual funds mentioned in a prominent Wall Street Journal “Category Kings” ranking list, compared to those funds which just missed making the list. This flow increase is about seven times larger than extra flows due to the well-documented performance-flow relation. Other funds in the same fund complex receive substantial extra flows as well, especially in smaller complexes. There is no increase in flows when the Wall Street Journal publishes similar lists absent the prominence of the Category Kings labeling. We show mutual fund managers react to the incentive created by the media effect in a strategic way predicted by theory, and present evidence for the existence of propagation mechanisms including increased fund complex advertising subsequent to having a Category King and increased efficacy of subsequent fund media mentions.
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Discrimination, Social Risk, and Portfolio Choice
Yosef Bonaparte et al.
University of Miami Working Paper, November 2016
Abstract:
This study examines whether social discrimination affects the risk perceptions and, subsequently, the investment decisions of individual investors. We conjecture that minority groups such as gays/lesbians, African Americans, and women, who are more likely to experience discrimination, over-estimate their risk exposures (i.e., they experience social risk) and invest more cautiously. Consistent with our conjecture, we find that minorities with high social risk participate less in the stock market and allocate a lower proportion of their wealth to risky assets. These results indicate that non-financial risks, such as social risk, influence financial risk-taking behavior of U.S. households.
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Does Local Religiosity Affect Organizational Risk-Taking? Evidence from the Hedge Fund Industry
Lei Gao
Iowa State University Working Paper, November 2016
Abstract:
We examine the impact of local religious beliefs on organizational risk-taking behaviors using hedge funds as a new and unique setting. We find that local religiosity is significantly negatively related to both total and idiosyncratic volatilities of hedge funds during 1996-2013, even after controlling for endogeneity using managers’ college-location religiosity. Consistent with the local preference channel, the impact of local religiosity on risk-taking is only pronounced among funds for which local managers and investors are more important, namely semi-directional, young, and small funds. Further, hedge funds located in more religious counties tend to hold less risky stocks and diversify their stock portfolios across industries, thus contributing to lower hedge fund risk-taking. Overall, our evidence suggests that local religiosity may motivate hedge fund managers to reduce risk.
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Sensation Seeking, Sports Cars, and Hedge Funds
Stephen Brown et al.
NYU Working Paper, December 2016
Abstract:
We find that hedge fund managers who own powerful sports cars take on more investment risk. Conversely, managers who own practical but unexciting cars take on less investment risk. The incremental risk taking by performance car buyers does not translate to higher returns. Consequently, they deliver lower Sharpe ratios than do car buyers who eschew performance. In addition, performance car owners are more likely to terminate their funds, engage in fraudulent behavior, load up on non-index stocks, exhibit lower R-squareds with respect to systematic factors, and succumb to overconfidence. We consider several alternative explanations and conclude that manager revealed preference in the automobile market captures the personality trait of sensation seeking, which in turn drives manager behavior in the investment arena.
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Why Does Capital No Longer Flow More to the Industries with the Best Growth Opportunities?
Dong Lee, Han Shin & René Stulz
NBER Working Paper, December 2016
Abstract:
With functionally efficient capital markets, we expect capital to flow more to the industries with the best growth opportunities. As a result, these industries should invest more and see their assets grow more relative to industries with the worst growth opportunities. We find that industries that receive more funds have a higher industry Tobin’s q until the mid-1990s, but not since then. Since industries with a higher funding rate grow more, there is a negative correlation not only between an industry’s funding rate and industry q but also between capital expenditures and industry q since the mid-1990s. We show that capital no longer flows more to the industries with the best growth opportunities because, since the middle of the 1990s, firms in high q industries increasingly repurchase shares rather than raise more funding from the capital markets.
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Global Economic Growth and Expected Returns Around the World: The End-of-the-Year Effect
Stig Møller & Jesper Rangvid
Management Science, forthcoming
Abstract:
Global economic growth at the end of the year strongly predicts returns from a wide spectrum of international assets, such as global, regional, and individual-country stocks, FX, and commodities. Global economic growth at other times of the year does not predict international returns. Low growth in the global economy at the end of the year predicts higher returns over the following year. It also predicts the global business cycle. When global economic growth at the end of the year is low, investors expect a worsening of the global business cycle and increase their required returns.
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A Proposal to Limit the Anti-Competitive Power of Institutional Investors
Eric Posner, Fiona Scott Morton & Glen Weyl
University of Chicago Working Paper, November 2016
Abstract:
Recent scholarship has shown that mutual funds and other institutional investors may cause softer competition among product market rivals because of their significant ownership stakes in competing firms in concentrated industries. While recent calls for litigation against them under Section 7 of the Clayton Act are understandable, private or indiscriminate government litigation could also cause significant disruption to equity markets because of its inherent unpredictability and would fail to eliminate most of the harms from common ownership. To minimize this disruption while achieving competitive conditions in oligopolistic markets, the Department of Justice and the Federal Trade Commission should take the lead by adopting a public enforcement policy of the Clayton Act against institutional investors. We outline such a policy in this article. Investors in firms in well-defined oligopolistic industries must choose either to limit their holdings of an industry to a small stake (no more than 1% of the total size of the industry) or to hold the shares of only a single “effective firm” per industry. Investors that violate this rule face government litigation. Using simulations based on empirical evidence, we show that under broad assumptions this rule would generate large competitive gains while having minimal negative effects on diversification and other values. The rule would also improve corporate governance by institutional investors.
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The Relevance of Broker Networks for Information Diffusion in the Stock Market
Marco Di Maggio et al.
Harvard Working Paper, October 2016
Abstract:
This paper shows that the network of relationships between brokers and institutional investors shapes the information diffusion in the stock market. We exploit trade-level data to show that trades channeled through central brokers earn significantly positive abnormal returns. This result is not due to differences in the investors that trade through central brokers or to stocks characteristics, as we control for this heterogeneity; nor is it the result of better trading execution. We find that a key driver of these excess returns is the information that central brokers gather by executing informed trades, which is then leaked to their best clients. We show that after large informed trades, a significantly higher volume of other investors execute similar trades through the same central broker, allowing them to capture higher returns in the first few days after the initial trade. The best clients of the broker executing the informed trade, and the asset managers affiliated with the broker, are among the first to benefit from the information about order flow. This evidence also suggests that an important source of alpha for fund managers is the access to better connections rather than superior skill.
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Robo-Journalism and Capital Markets
Elizabeth Blankespoor, Ed deHaan & Christina Zhu
Stanford Working Paper, November 2016
Abstract:
In 2014, the Associated Press (AP) began using algorithms to write media articles about firms’ earnings announcements. These “robo-journalism” articles synthesize information from firms’ press releases, analyst reports, and stock performance, and are widely disseminated by major news outlets a few hours after the earnings release. The articles are available for thousands of firms on a quarterly basis, many of which previously received little or no media attention. We use AP’s staggered implementation of robo-journalism to examine the effects of media synthesis and dissemination, in a setting where the articles are devoid of private information and are largely exogenous to the firm’s earnings news and disclosure choices. We find compelling evidence that automated articles increase firms’ trading volume and liquidity. We find no evidence that the articles improve or impede the speed of price discovery. Our study provides novel evidence on the impact of pure synthesis and dissemination of public information in capital markets, and initial insights on the implications of automated journalism for market efficiency.
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Did Government Regulations Lead to Inflated Credit Ratings?
Patrick Behr, Darren Kisgen & Jérôme Taillard
Management Science, forthcoming
Abstract:
Securities and Exchange Commission (SEC) regulations in 1975 gave select rating agencies increased market power by increasing both barriers to entry and the reliance on ratings for regulations. We test whether these regulations led to ratings inflation. We find that defaults and negative financial changes are more likely for firms given the same rating if the rating was assigned after the SEC action. Furthermore, firms initially rated Baa in the post-regulation period are 19% more likely to be negatively downgraded to speculative grade than firms rated Baa in the pre-regulation period. These results indicate that the market power derived from the SEC led to ratings inflation.
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Samuel Hartzmark & David Solomon
University of Chicago Working Paper, November 2016
Abstract:
We show that investors trade as if they consider dividends and capital gains in separate mental accounts, without fully appreciating that dividends come at the expense of price decreases. Investors trade differently in response to each component - trading patterns such as the disposition effect are driven by price changes, with dividends being ignored or downweighted. Investors hold dividend-paying stocks longer, and are less sensitive to price changes, consistent with dividends being valued as a separate desirable attribute of stocks. The demand for dividend-paying stocks is higher when interest rates and recent market returns are lower, consistent with investors comparing dividends to other income streams and capital gains. Investors spend the proceeds of each component differently - mutual funds and institutions rarely reinvest dividends into the stocks from which they came, but instead purchase other stocks. This leads to predictable marketwide price increases on days of large aggregate dividend payouts, including stocks not paying dividends.
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Stock Market Overvaluation, Moon Shots, and Corporate Innovation
Ming Dong, David Hirshleifer & Siew Hong Teoh
University of California Working Paper, November 2016
Abstract:
We test how market overvaluation affects corporate innovative activities and success. We find that estimated stock overvaluation is very strongly associated with R&D spending, innovative output, and measures of innovation originality, generality and novelty. R&D spending is much more sensitive than capital investment to overvaluation. Although both channels operate, the effects of misvaluation on R&D spending come more from direct catering of firms to investor optimism than via equity issuance. The sensitivity of R&D and innovative output to misvaluation is greater among growth, overvalued, and high turnover firms. This evidence suggests that market overvaluation may have social value by increasing innovative output and by encouraging firms to engage in ambitious ‘moon shots.’
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Retail Short Selling and Stock Prices
Eric Kelley & Paul Tetlock
Review of Financial Studies, forthcoming
Abstract:
Using proprietary data on millions of trades by retail investors, we provide the first large-scale evidence that retail short selling predicts negative stock returns. A portfolio that mimics weekly retail shorting earns an annualized risk-adjusted return of 9%. The predictive ability of retail short selling lasts for one year and is not subsumed by institutional short selling. In contrast to institutional shorting, retail shorting best predicts returns in small stocks and those that are heavily bought by other retail investors. Our findings are consistent with retail short sellers having unique insights into the retail investor community and small firms’ fundamentals.