Big Investors Hone an Edge
Institutions' research seems to pay
Each year, equity institutional investors--mutual funds, pension funds, insurance companies, and the like--spend billions of dollars on security analysis to stay ahead of the game. Given the wide divergence in institutional performance, however, some critics have charged that such expenditures are excessive and produce little if any net benefits in trading profits.
In a new study, Scott Gibson of the University of Minnesota and Assem Safieddine of Michigan State University shed light on the issue by comparing changes in total institutional ownership of individual stocks during each quarter from 1980 to 1994 with stock returns over the same quarters.
Their finding: During the 15-year period, the 20% of stocks with the largest quarterly increase in institutional ownership (as a percentage of a company's outstanding shares) consistently posted positive returns. And the 20% of stocks registering the largest declines in institutional ownership consistently lost money. The gap between the top and bottom groups averaged 7.2% a quarter over the entire period--and a huge 12.1% from 1990 to 1994 (chart).
Of course, the fact that prices of individual stocks rose or fell in the same quarters that institutions as a group were buying or selling shares doesn't necessarily mean that the institutions' security research had paid off. Rather than reflecting new pertinent information that pushed prices in the "right" direction, it's possible that the very weight of institutional trading simply moved the market temporarily. After all, institutional ownership of stocks rose from 20% of the market in 1980 to 40% in the early 1990s.
To figure out what was happening, the two researchers compared the timing of institutional ownership shifts with the timing of earnings forecast revisions by brokerage firms. They reasoned that if the institutions were truly bringing new information to the market, then their trading should on average anticipate subsequent earnings forecast revisions by the brokerage houses.
That, in fact, is exactly what they found. Net stock purchases by institutions in one quarter tended to precede upwards earnings forecast revisions by brokerage houses in the next quarter. Indeed, the ability of such institutional trading to anticipate the direction of future earnings forecast revisions has grown stronger in recent years.
The bottom line is that the big bucks that institutions as a group shell out for research activities do seem to pay off. Compared to individual investors--who, of course, buy the stocks that institutions unload and often rely on their friendly brokers for advice--the institutions appear to be ahead of the informational curve.BY GENE KORETZReturn to top
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The Downside of the '98 Boom
As the bull roared, most stocks fell
Institutional investors as a group may be better informed than individuals, but judging from the performance of the most popular stock market indexes, it appears that just about everyone should have done well last year. After all, the Standard & Poor's 500-stock index gained 26.7% for the year, the fourth year in a row of 20%-plus gains. Meanwhile, the Dow Jones industrial average was up 16.1% (not counting dividends), while the NASDAQ Composite jumped 39.6%.
A cakewalk for investors? Not according to Salomon Smith Barney equity strategists Jeffrey M. Warantz and John L. Manley Jr. While it's hardly news that the big gains last year were racked up by the largest-cap stocks, they point out that the market boom was far more narrowly based than most people appreciate.
On average, they report, stocks with a capitalization of more than $20 billion at the start of the year climbed by 25.9%, and those in the $5 billion-to-$20 billion range rose by 6.2%. But the average stock in other cap groups--including caps valued from $2 billion to $5 billion--declined in price, with those under $250 million sliding more than 24%. Indeed, two-thirds of all U.S. stocks actually ended the year in the loss column.
As for the S&P 500's surge, the analysts note that just 10 stocks accounted for 43% of the gain, 25 stocks for 67%, and 33 stocks for over 75%. In the end, they say, 1998 will be remembered as the year "the largest stocks had a really big performance party, and everyone else stayed at home."BY GENE KORETZReturn to top