Information in Financial Markets: Who Gets It First?

Nathan Swem

University of Texas at Austin – Department of Finance


This paper examines the timing of information acquisition of hedge funds, mutual funds, and broker/dealer analysts. I find hedge fund trading anticipates analyst information, while mutual fund trading does not. Specifically, hedge fund net buying predicts more analyst upgrade reports in the next quarter, and predicts fewer downgrade reports. Secondly, I find hedge funds and mutual funds respond differently to analyst information: in the quarter following analyst reports hedge funds “defy” analyst recommendations, while mutual follow the analysts. Finally, I find hedge funds perform best among stocks with highest research coverage and institutional ownership. I relate these findings to information acquisition theory in settings where investors acquire information at different times.

Information in Financial Markets: Who Gets It First? – Introduction

The informational efficiency of asset prices is one of the central themes of financial economics. However, relatively little is known about how information gets incorporated into prices. Investors have access to information contained in publicly disseminated research such as analyst reports, but much of the information contained in stock prices stems from the trading decisions of institutions like mutual funds and hedge funds that employ internal research staffs to generate private information. While analyst information has been extensively studied, information generated privately by investment firms is not publically available and is largely overlooked in existing literature.

This paper examines investment firms’ private information by comparing mutual fund and hedge fund trades with analyst research reports published in subsequent periods. I impute trade timing by examining the 13F filings of a new and comprehensive sample of 1,150 hedge fund firms, and a matched sample of mutual funds. I compare the direction of these trades to subsequent upgrade and downgrade reports published by covering analysts. My main result is that the direction of hedge fund trades anticipates subsequent analyst upgrade and downgrade reports, but mutual fund trades do not.

I find that analyst upgrade reports generate abnormal returns averaging +3.1%, and analyst downgrades generate abnormal returns averaging -3.8%, which suggests these analyst reports contain significant new information. I use OLS regressions to show a positive and statistically significant relation between the direction of hedge fund trades and the following quarter’s analyst upgrade and downgrade reports. I use Poisson and negative binomial regressions to examine the economic significance of the hedge fund prediction effect. These regressions indicate a one standard deviation increase in hedge fund net buying increases the marginal likelihood that an upgrade report will be published in the next quarter by 11%. In addition, hedge fund net buying decreases the marginal likelihood of a downgrade published in the subsequent quarter by 6%. By contrast, I find mutual fund trades do not predict analyst reports.

My second result is that hedge funds and mutual funds react differently to analyst information. I use OLS regressions to show that in the quarter following analyst reports, mutual funds trade in a direction consistent with the advice of the analysts, but hedge funds “defy” analyst reports and trade in the opposite direction. Specifically, I find analyst net upgrades significantly predict mutual fund net buying, while analyst net upgrades significantly predict hedge fund net selling.

The results outlined above are consistent with a number of theoretical papers that have explored the information acquisition process. For example, Hirshleifer, Subrahmanyam, and Titman (1994, hereafter “HST”) present a multi-period model in which some competitive risk-averse investors receive information before others. As described in HST, early informed investors benefit from the activities of investors who subsequently become informed because the “later informed” allow the early informed to trade more aggressively on their information and exit trades earlier. My first two empirical results suggest that in general hedge funds trade in a manner consistent with “early informed” investors in the HST setting, and that mutual funds trade in a manner consistent with the late informed.

Financial Markets

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H/T Meb Faber