Which Institutional Investors Trade Based on Private Information About Earnings and Returns?

Abstract

Recent work presents evidence that certain groups of institutional investors are able to trade profitably based on private information about earnings and returns. We contribute to this literature in three ways. First, we test whether certain private information proxies are consistent with the creation and liquidation of positions based on private information. Second, we introduce private information proxies that reflect the size and nature of an institution's position in each portfolio firm. Third, we use a methodology that examines multiple investor characteristics simultaneously at the institution-firm-level. We find that changes in ownership by institutions that have large positions in a specific firm are consistent with trading based on private information. However, other previously-documented proxies for private information produce results that are more consistent with risk-based trading (e.g., investment style, portfolio turnover) or that are insignificant in the presence of the other proxies (e.g., fiduciary type). We also find that informed trading is more prevalent in return-based measures (vs. earnings-based measures) and in smaller firms. Tests for interactions among private information proxies reveal that informed trading is most evident when the large positions in firms are newly initiated and when they are taken by investment advisers and by large institutions. Finally, we find that institutions following growth strategies exhibit momentum trading in positions held less than one year and informed trading in positions held more than one year, suggesting that the information advantages to investment styles accrue over time.

Keywords: Institutional investors, private information, informed trading, stock returns

JEL Classification: M41, G20, G14, G32