Hardworking Hedge Funds Might Have the Upper Hand
This post originally appeared in Money Stuff.
Public companies in the U.S. have to make public filings -- annual and quarterly reports on Form 10-K and 10-Q, announcements of material events on Form 8-K, descriptions of trading by insiders and big shareholders, etc. -- on the Securities and Exchange Commission's Edgar website. Should you read them? For amateur investors that is perhaps a difficult question: There is an obvious conventional wisdom that you should read them so you can be informed about the companies you invest in, but there is also an argument that reading SEC filings gives casual retail investors merely the illusion of competence. After all these filings are publicly available and you are competing with professionals whose only job it is to analyze stocks; surely those professionals are also reading the filings and then also doing a lot of other research that you just can't do.
On the other hand, if you yourself are a professional stock investor, sure, go ahead and read the filings. The company is telling you what it thinks you need to know about its operations and finances, so you should probably take a look. It's not going to give you a huge advantage over anyone else -- everyone else can read the filings too -- but it seems like the sort of bare minimum work you'd do to understand a company before investing in it. Right?
Here is kind of a wild paper from Alan Crane, Kevin Crotty and Tarik Umar of Rice University called "Do Hedge Funds Profit From Public Information?" that looks into whether hedge funds download filings from Edgar, and whether it helps. On the first question, some do, some don't, and "while the median fund-month download amount is only 4 filings, the mean is 672." On the second question, it helps:
Hedge funds that access any filing have higher abnormal returns in the next month compared to funds that do not access filings. The result is statistically significant and economically large, representing a difference in abnormal returns of about 1.5% per year. More intensive information acquisition is also associated with higher subsequent abnormal returns, with the above-median users generating 2%-per-year higher returns than non-users.
It is hard to know what to make of that. One obvious interpretation is that markets do not efficiently incorporate the most basic public information into stock prices, and if you go and read companies' public filings you can outperform the market. A flip side of that interpretation is that some hedge funds do not do that most basic part of their job, and that if you don't bother to read companies' public filings then of course you are going to underperform your peers.
But other interpretations are available. For instance the paper does not seem to be limited to fundamental long-short equity hedge funds, where actual reading of filings would be most relevant, and you could imagine that "number of Edgar downloads" might mostly index what style of fund you are rather than how seriously you take your job. A quantitative macro fund -- or an international stock fund for that matter -- would not use Edgar much; a fundamental U.S. equity fund would use Edgar a medium amount; a quantitative equity fund might scrape hundreds of Edgar documents a day. ("Even within funds, performance is better in periods when those funds access more," write the researchers, which "suggests that the relation we observe is more than just an indicator of fund type.")
There are confounding factors. The sample of "hedge funds" seems both over- and under-inclusive. There are lots of ways to get Edgar filings without accessing Edgar -- from the Bloomberg terminal, for instance, or from the companies' own websites -- so it's not clear that actual Edgar download activity is a good indicator of use of public filings. And it's not clear that there's a causal relationship between the outperformance and the downloading. Still it is an odd result. You would expect this sort of basic public information to be disseminated so widely and efficiently that you couldn't beat the market just by reading it. But perhaps you can.
But here's another wild thing about this paper: You can go find out which hedge funds accessed which documents on Edgar! I mean, that seems wild to me, but the authors' literature summary mentions several other papers that use the same technique. In each case researchers use public records to figure out which hedge funds own which IP addresses, and then match the IP addresses to Edgar traffic logs that the SEC makes available. (Here they are.) The Edgar logs are posted quarterly with a six-month lag, and you can't necessarily match up every hedge fund with an IP address, so you can't find out, say, what companies Dan Loeb or Bill Ackman are looking at today. But you can at least find out what companies some hedge funds were looking at a year ago, and what sort of research they did. It might tell you interesting things about their investing processes. I would definitely read a second-order paper examining usage of the Edgar logs: Can hedge funds profit from looking at data about what other hedge funds are looking at?
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