Blog - Investing Notes
April 1, 2008 - Institutional Trading, Returns and Strength of Anomalies
Are there exploitable differences in returns for stocks with heavy versus light
institutional trading activity? In his March 2008 paper entitled "Trader
Composition and the Cross-Section of Stock Returns", Tao Shu analyzes the
impact of institutional trading activity on the returns of individual stocks
and on the strength of the momentum
effect, post earnings-announcement drift (PEAD), the value
premium and the investment effect. He calculates institutional trading activity
at a quarterly frequency by dividing the aggregate absolute change in reported
institutional holdings of a stock by the contemporaneous total quarterly trading
volume for the stock. Using holdings data as reported via SEC
Form 13F and associated stock trading volume and return data for the period
1980-2005, he concludes that:
- Institutions account for about half of all trading volume.
- Institutional trading activity is significantly different from institutional
ownership, with a correlation of only 0.41.
- Both institutional ownership and firm characteristics affect institutional
trading activity, but the most important determinant is historical trading
activity. Persistence in institutional trading activity is stronger for stocks
with light analyst coverage.
- Stocks with low institutional trading activity underperform
stocks with high institutional trading activity by 0.25% to 0.53% per month
depending on risk adjustments applied. The difference in performance is most
pronounced for liquid stocks (1.03% per month for the most liquid but practically
zero for the least liquid).
- Major return anomalies are much stronger in stocks with low institutional
trading activity. Controlling for institutional ownership and other factors,
stocks in the lowest third of institutional trading in the prior quarter compared
to those in the top third (re-ranked monthly) exhibit:
- Momentum (six-month formation period, one-month skip
period and six-month holding period) stronger by 0.40% per month.
- PEAD (from two days before announcement through one
day after) stronger by 0.46% per month.
- A value (high book-to-market minus low) premium larger
by 0.97% per month.
- An investment effect (low capital investment minus high)
bigger by 0.57% per month.
- These findings suggest a positive relationship between (presumably informed
and sophisticated) institutional trading activity and market efficiency.
In summary, evidence suggests that stocks with low institutional trading
activity (distinct from institutional ownership) tend to be overpriced, with
amplified return anomalies.
For related research, see Blog
Synthesis: Big Ideas for Investing/Trading.
