My basic investing article cheerleads for index funds, largely based on Burton Malkiel’s 1973 research (subsequently updated and currently available as A Random Walk Down Wall Street (11th Edition)). “How Some Investors Get Special Access to Companies” is a September 27, 2015 Wall Street Journal article that should encourage a little doubt among the indexing believers.
Public companies are allowed to meet with favored investors privately:
The result is a booming back channel through which facts and body language flow from public companies to handpicked recipients. Participants say they’ve detected hints about sales results and takeover leanings. More common are subtle shifts in emphasis or tone by a company.
Access usually is controlled by brokers and analysts at Wall Street securities firms, who lean on their relationships with companies to secure meetings with top executives. Invitations are doled out to money managers, hedge funds and other investors who steer trading business to the securities firms, which in turn provide the investors with a service called “corporate access.”
Investors pay $ 1.4 billion a year for face time with executives, consulting firm Greenwich Associates estimates based on its surveys of money managers. The figure represents commissions allocated by investors for corporate access when they steer trades to securities firms.
A recently published paper in the Journal of Law and Economics analyzed the trading behavior of dozens of investors who met during a 5½-year period with senior management of a company listed on the New York Stock Exchange.
While the paper doesn’t identify the company or investors, researchers concluded that the investors who got face time with management made better trading decisions. Several large hedge funds met the company as frequently as once a quarter.
Brian Bushee of the University of Pennsylvania’s Wharton School and two other academic researchers concluded that trading volume picked up around the time of the private meetings. Trades made then were more likely to be profitable than trades made at other times.
Along the same lines, but not obviously actionable for the typical investor… “Insiders Beat Market Before Event Disclosure: Study” (WSJ, September 14, 2015):
Corporate executives and board members regularly make market-beating returns from buying and selling their companies’ stock in the days before disclosing a significant event, according to a study that says it has found a link between insider knowledge and investment profits.
On average, the officials netted about 0.4 percentage point over a broad market index between the time of their trades and the market close after the disclosure. These gains, realized over the span of a few days, would be much larger on an annualized basis.
When officials bought shares outright—rather than by exercising options received as compensation—the gains were even better, at about 1.6 percentage points over the index.
The longer companies waited to make disclosures, the better the returns, according to the study. When companies used the full four-business-day window, the average excess profit rose to 1.95 percentage points.
What does it look like in practice? “Towers Watson CEO Sold Stock Before Big Deal:
John Haley netted nearly $ 10 million on preannouncement sales” (WSJ, September 23, 2015):
In early March, when merger talks were under way between Towers Watson and insurance broker Willis Group Holdings PLC, Mr. Haley exercised 106,933 stock options and sold the underlying shares for a $ 9.7 million profit, according to regulatory filings. The sale was Mr. Haley’s first in more than a year and shed 55% of his stake in Towers Watson…
When the roughly $ 9 billion deal was announced on June 30, Towers Watson shareholders criticized it, sending the Arlington, Va., company’s stock down nearly 9% that day. Their beef: the deal’s price tag, which valued Towers Watson at $ 125.13 a share, or about 9% less than the prior day’s close.
Maybe the future of efficient investing has to include some managed funds that are big enough to pay for and acquire access to inside information?
Philip Greenspun’s Weblog