The Institutional Investor Impact on Stock Prices.
| Autor | Borges, Elaine |
1 Introdution
The purpose of this study is to analyze the impact of mutual fUnds trading stocks together for consecutive periods on the price of these stocks. The tendency of the funds to carry out buy-sell transactions similar to each other, as if one copied the other, was called in the literature institutional herd effect. This effect was positively identified in Brazil and in the world by a series of studies such as Klemkosky (1977), Kraus and Stoll (1972), Friend, Blume and Crockett (1970) and Tariki (2014). The present study investigates the impact of the institutional herd effect of Brazilian funds on stock prices.
There are three possible explanations for the existence of the institutional herd effect. The first is that funds seek to follow the leader, that is, the fund that has managed to get the best results. The second is based on the hypothesis that funds receive the same private information and observe the same financial indicators when choosing stocks, so the herd effect would be a natural consequence of this informational equality. Finally, the third is based on the asymmetry of reputational effects: funds prefer to act in a similar way since being a negative highlight in the industry could have very negative consequences and may not be worth the risk, in which case fund managers would not have incentive to take risk.
One of the consequences of the institutional herd effect that motivates studies directed to it is the distortions of stock prices caused by pressures of supply or demand, consequence of the funds trading. At first, for being well-informed investors, funds would be expected to contribute to bringing stock prices to their equilibrium by buying undervalued shares and selling the overvalued ones, acting in this way as price stabilizers. However, the existence of the institutional herd effect advocates that funds would be price destabilizing, that is, by trading shares, funds would push their prices away from their equilibrium, leading to a price deviation in the short term, followed by a price reversal in the medium term. According to this hypothesis, stocks purchased jointly by funds would have their prices increased in the short term, due to the increased demand generated by funds, and in the medium term prices would suffer a reduction, thus generating an average return. The same would happen with stocks sold by funds, in the short term their prices would suffer a reduction due to supply increase, and in the medium term this reduction would be reversed.
Initially, studies that address the institutional herd effect on stock prices have evaluated their short-term impacts. Wermers (1999) and Sias (2004) studied the impact of American funds trading stocks on the price of these stocks and both found evidence in the short term of price increases of the stocks sold and price decreases of stocks that was bought by funds. However, Bikhchandani, Hirshleifer, and Welch (1992), and Sharfstein and Stein (1990) have identified that the institutional herd effect creates persistence of decision over time, that is, when a fund buys a particular stock in multiple periods other funds mimic their choice more broadly, emphasizing the importance of observing the impact of the institutional herd effect in the medium term and in consecutive periods. Dasgupta, Prat, and Verardo (2011) have taken this feature of the institutional herd effect into account and have created a variable called persistence to record the number of consecutive repetition of stocks purchases and sales by the pool of US funds over time and their impact on both short and medium term prices. In the short term the results have remained, stocks bought (sold) by funds have their prices increased (reduced). The authors, however, found evidence that in the medium term the relationship between persistence and prices is reversed, that is, shares persistently bought by the pool of funds present low prices, and shares sold for consecutive periods present their prices increased in the medium term. This evidence corroborates the destabilizing hypothesis of prices, that funds push equity prices away from their equilibrium, generating a rise (decrease) in the price of shares bought (sold) at first, and then a reversal of that trend, contradicting the argument that funds would know how to choose winning shares.
In 2016, the Brazilian investment funds industry reached 3.1 trillion in equity, making it the seventh largest in the world with more than 12 million quota holders. According to the 2015 investment fund industry yearbook, conducted by the Getulio Vargas Foundation (FGV) and the Brazilian Association of Financial and Capital Market Entities (Anbima), the industry has almost doubled in size in the last 5 years, and this expressive growth has been occurring for at least 20 years. In addition, funds have a significant presence on the Sao Paulo Stock Exchange (B3), being one of the main groups that trade stocks, since Brazilian people does not yet have the culture to invest directly in the stock exchange, which reinforces the importance of investigating the role of funds in adjusting stock prices in Brazil.
In addition to the expressiveness of the size of the fund industry in the country and its important presence in B3, previous studies such as Borges and Martelanc (2015) identified a higher percentage of funds with ability to generate above-average returns in Brazil compared to the results presented by Fama (2010) in the USA, leading to believe that Brazil has a greater market inefficiency than developed countries, and that the role of funds in the adjustment of stock prices in Brazil could be more preponderant than what was identified in a similar study in the USA. Believing that these scenario differences may be an indication that the impact of funds on share prices here in Brazil is different from that identified in the US, this study is relevant.
In order to study the impact of institutional investor on the stock price, the monthly database for the composition of Brazilian fund's portfolio maintained by Anbima was used; this database is relatively recent in Brazil and therefore not yet studied, since before 2009 funds did not have to disclose their portfolio on specific dates. Fixed-effects panel regression analyzes were performed to identify the relationship between persistence, which measures how many consecutive periods a particular share was bought or sold by the pool of funds, and the returns of the same stock in the short and medium term.
Results differ from those presented in the American study, as expected. Stocks that are purchased by the pool of funds persistently have reduced returns, and stocks sold have increased returns in both the short and medium term. In addition, the sample that gathered small funds with active strategy, trading small caps, presented the most statistical and economic relevance in all periods. These results allow us to question the ability of small fund managers to select assets and the timing of their transactions, as well as their contribution as well-informed investors to the equilibrium of capital market prices.
2 theoretical references
2.1 International Studies
Some of the earliest published studies with evidence of the institutional herd effect were Klemkosky (1977), Kraus and Stoll (1972) and Friend, Blume and Crockett (1970). Klemkosky (1977) has identified that institutional investors often tended to pre-dominate on one side of the market (buying or selling) for a given stock at any given time, thereby creating an imbalance. The author found evidence of the follow the leader strategy among funds. Kraus and Stoll (1972) aimed to identify the contribution of institutional investors block trades in market efficiency of the stock exchange, and were able to determine the tendency to herd in these institutions.
In the same line of thought, De Bondt and Thaler (1985) also identified the herd effect in investments, the main objective of the authors was to identify if there was an exaggerated reaction on the part of stock investors, and were found consistent evidences of exaggerated reaction and later reversion to returns average. Lakonishok, Shleifer, and Vishny (1992) found evidence of both positive feedback and herding in pension funds, particularly trading small caps. Grinblatt, Titman, and Wermers (1995) and Wermers (1997) have documented that the vast majority of funds use packaged strategies or use positive feedback of other managers from previous periods.
Other studies sought to explain the institutional herd effect; Scharfstein and Stein (1990) conclude that asset managers may want to avoid reputational risk that would come from a totally different and original investment strategy. If successful the premium would be great, but if the strategy failed, this manager would be the one to have to explain poor performance. Froot, Scharfstein and Stein (1992) and Hirshleifer, Subrahmanyam and Titman (1994) conclude that fund managers make decisions together because they receive similar private information and refer to the same financial indicators. Bikhchandani, Hirsh-leifer, and Welch (1992) argue that managers can infer the same private information received by well-informed investors through their latest asset purchase and sale transactions, and then negotiate in the same direction as following the leader. Finally, Falkenstein (1996) analyzes that institutional investors may share the same risk aversion in relation to shares with the same characteristics, e.g. liquidity.
With respect to the relationship between the institutional herd effect and the stock price in the short term, Wermers (1999) shows evidence that highly-purchased shares by funds outperform well-sold shares in up to two quarters. Sias (2004) has found evidence that institutional demand is positively correlated to prices in the short term. In the medium term, this relationship is reversed. Dasgupta, Prat and Verardo (2011)...
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