Independent Institutional Investors and Equity Returns

1
Independent Institutional Investors and Equity
Returns

• Yawen Jiao and Mark Liu
• Discussed by
• Xuemin (Sterling) Yan, University of Missouri

Burridge Center Conference University of Colorado
November 5-6, 2009
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Institutional Investors

• U.S. capital markets have become increasingly
  institutionalized
• Institutional investors hold 68 of the U.S.
  equity based on market value at the end of 2007
• In comparison, institutions hold 32 of the
  equity market in 1980
• Much of the growth occurs in the mutual fund
  industry and more recently in hedge fund industry
• Institutional trading accounts for gt75 of all
  trading in U.S. stocks

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Research Questions

• Institutional investors have received
  considerable attention from academics.
• Investments
• Corporate governance
• Do institutional investors have superior
  investment skills?
• Do institutional investors contribute to market
  efficiency?

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Institutions vs. Individuals

• Individual investors
• Naïve, unsophisticated
• Subject to behavioral biases, e.g., sentiment,
  overconfidence, biased expectations
• Dumb money
• Institutional investors
• Sophisticated, rational, professionals with more
  abundant resources
• Have an informational advantage, i.e., better at
  collecting and processing information
• Smart money

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Research Questions

• Do institutional investors have superior
  investment skills?
• Do institutional investors contribute to market
  efficiency?
• The answer seems to be yes to both of these
  questions if you adopt the view that institutions
  are sophisticated and rational while individuals
  are naïve and biased

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Evidence

• On average, mutual funds underperform the market
  after fees
• There is little evidence of performance
  persistence
• French (2008)
• Return anomalies such as value, momentum,
  earnings announcement, accruals, net issue, and
  asset growth effects
• Brunnermeirer and Nagel (2004)
• Limits of arbitrage (Shleifer and Vishny (1997))

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Agency Problems

• Institutional investors differ from individual
  investors in another critical area
• Institutions are delegated money managers
• Classic principal-agent problem
• Fund shareholders/investors would like to
  maximize risk-adjusted returns
• Fund companies/money managers would like to
  maximize their own profits and job security
• The interest of the money manager may not be
  perfectly aligned with that of the underlying
  shareholders

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Evidence on Agency problems

• Late trading and market timing scandals of 2003
• Career concerns ?preference for glamour stocks
  and past winners and take less risks (Chevalier
  and Ellison (1999))
• Money managers are evaluated against each other ?
  herding
• Money managers are evaluated frequently ?
  short-termism
• Quarterly disclosure of holdings ? Window
  dressing and portfolio pumping

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Agency problems

• Risk-shifting behavior
• Cross-fund subsidization
• Extra layer of agency problem in pension funds
  creates a bias against passive management and a
  bias against internal management
• Public or private (Ferris and Yan (2009))
• Conflicts of interest in financial conglomerates
• Equity Research, Investment banking, Money
  management
• Hao and Yan (2009)

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Research Questions

• Do institutional investors have superior
  investment skills?
• Do institutional investors contribute to market
  efficiency?
• The presence of agency conflicts potentially has
  a large negative impact on both of these issues

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Jiao and Liu (2009)

• Investigates the relation between institutional
  ownership/trading and future stock returns and
  find that the positive relation driven by
  independent institutions
• Builds on Gompers and Metrick (2001) and Yan and
  Zhang (2009)

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Jiao and Liu (2009)

• The research question is interesting and well
  motivated.
• Speak to both issues of informational advantage
  and agency conflicts
• The results make a lot of sense to me given the
  existing evidence

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Comment 1

• Extend Gompers and Metricks (2001) and Yan and
  Zhang (2009) more significantly by
• Evaluate the informational advantage differently,
  e.g., evaluate the performance of institutional
  holdings or fund returns, and examine the
  persistence of these performance differences

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Comment 2

• Thinking more deeply about the sources of
  differential results between independent
  institutions and grey institutions
• Would be more convincing if can provide more
  direct evidence on the impact of business ties
• Interesting study in an important research area