IQ from IP: Simplifying Search in Portfolio Choice

by Huaizhi Chen, Lauren Cohen, Umit Gurun, Dong Lou, and Christopher J. Malloy

Overview — Mutual fund managers solve their complex “search problem” for superior investable returns by tracking—and trading—on very particular sets of firms and insiders. These sets are chosen strategically and remain very persistent over time, as does the outperformance these insiders’ trades afford to the given fund managers.

Author Abstract

Using a novel database that tracks web traffic on the SEC’s EDGAR servers between 2004 and 2015, we show that mutual fund managers gather information on a very particular subset of firms and insiders, and their surveillance is very persistent over time. This tracking behavior has powerful implications for their portfolio choice and its information content. An institution that downloaded an insider-trading filing by a given firm last quarter increases its likelihood of downloading an insider-trading filing on the same firm by more than 41.3% this quarter. Moreover, the average tracked stock that an institution buys generates annualized alphas of between 9% to 18% relative to the purchase of an average non-tracked stock. We find that institutional managers tend to track members of the top management teams of firms (CEOs, CFOs, Presidents, and Board Chairs) and tend to share educational and location-based commonalities with the specific insiders they choose to follow. Collectively, our results suggest that the information in tracked trades is important for fundamental firm value and is only revealed following the information-rich dual trading by insiders and linked institutions.