Institutional investors own more than two-thirds of corporate equities, and they account for an even greater percentage of trading volume. Because they make up such a large share of the market, when these pension funds, mutual funds, insurance companies, hedge funds, endowment funds, and other behemoth investors buy and sell based on news, it moves market prices for everyone.
Naturally, there has been much speculation over whether institutional investors have an advantage over other market players by receiving corporate news first or predicting it better. But new research from the University of Maryland’s Robert H. Smith School of Business finds they don’t have a systematic advantage at predicting news releases ahead of time; instead, the research finds that they have superior skills at interpreting the news and reacting (or not reacting) to the news with their trades of stocks.
Russ Wermers, Dean’s Chair in Finance, chairman of the Finance Department, and director of the Center for Financial Policy at Maryland Smith, co-authored the new study, forthcoming in the Review of Financial Studies, a top scholarly journal in finance. Wermers and his co-authors from McGill University and the University of Waterloo assembled what they call “the most comprehensive corporate news database academically studied, to date,” for the decade 2000-2010, with time stamps indicating exactly when corporate news first appeared through a news bulletin. They also used a high-frequency trading database that had details about the precise timing of trades made by institutional investors. Their trading database consisted of about 10 percent of all institutional investor trades over the same time period. They used both datasets to precisely study the sequence of timing of an initial news bulletin and the trades made by institutions in the stock being featured in the bulletin.
Importantly, the authors focused on “unanticipated news,” that is, news releases whose timing or content cannot be accurately known beforehand. As opposed to “anticipated news,” such as earnings announcements – which are pre-announced to occur at a particular date and time – unanticipated news occurs without warning in markets (such as the sudden death of a CEO or the surprise announcement of a merger of two companies). The research questioned if the impact on stock returns of such difficult-to-forecast news bulletins can be predicted or, alternatively, are interpreted quickly after they occur.
“Our results suggest that institutional investors do not systematically predict qualitative information embedded in unexpected corporate news releases; instead, they trade speedily on news once the information becomes public,” write the researchers. “Overall, we find that institutions’ trading advantages stem from their ability to process public information in a highly timely manner.”
There is a long-held belief in the investment community that institutional investors somehow get news early and trade accordingly, and this may be true in some cases, but the researchers’ findings show that institutions, when faced with unanticipated news releases, trade on the tone of the news quickly on the day of its release, and not sooner or later than that. In fact, the authors find that the bulk of trading by institutional investors occurs within 15-30 minutes of the initial news bulletin about a particular story about a corporation.
Because institutional investors are key to information quickly becoming incorporated into prices, a better understanding of how they do so adds insight into how such institutions improve market efficiency for all investors, say the researchers.
“Institutional Trading around Corporate News: Evidence from Textual Analysis,” is forthcoming in the Review of Financial Studies.
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