COLUMBUS, Ohio - When the stock markets rise or drop sharply in a day, don't blame unsophisticated individual investors for the volatility.
A new study suggests that it is large institutional investors -- especially mutual fund managers -- who drive dizzying daily changes in the stock market.
Researchers found that values of stocks owned predominantly by institutional investors surged more sharply than other stocks on days when the overall market rose sharply, and also dropped more sharply when the market fell precipitously.
In addition, stocks with high institutional ownership also experienced heavier trading than other stocks on days when the market moved sharply.
"These findings indicate that institutions herd together and trade with the momentum of the market on days when there are large moves in the stock market," said Deon Strickland, co-author of the study and assistant professor of finance at Ohio State University's Fisher College of Business.
"This is especially true of mutual fund managers. We're seeing that it's not the small individual investors who panic most in volatile markets."
Strickland conducted the study with Patrick Dennis of the University of Virginia. They presented their findings this month at a meeting of the American Finance Association.
For the study, the researchers examined how individual stocks fared between 1988 and 1995 on days when the major U.S. markets rose or fell by a large amount -- more than 2 percent. They then compared the returns of stocks that are primarily held by institutions -- mutual funds, pension funds and insurance companies -- to those that are primarily held by individuals.
In up markets, firms with high institutional ownership had significantly higher returns (2.2 percent) when compared with firms with low institutional ownership (1.32 percent). In down markets, stocks dominated by institutional owners lost more (-2.67 percent) than did other firms (-1.9 percent).
Similar results occurred when the researchers considered how much of the firms' stock was traded on days of high volatility. In up markets, firms with high institutional ownership had a stock turnover of 0.47 percent compared to just 0.23 percent for firms with low institutional ownership. In down markets, institutionally-dominated firms had a turnover of 0.44 percent, compared to 0.26 percent for other firms.
"This suggests that institutional money managers may be panicking and trading a lot more on days when the market is particularly volatile," Strickland said.
These results held up even when the researchers took into account a wide variety of factors that may affect stock prices and trading volumes for a particular company, such as firm size, average trading volume, and firm liquidity. The researchers also looked at "ordinary" days when the stock market did not rise or fall by at least 2 percent, and found that there was no significant difference in trading volume and returns between stocks owned predominantly by institutions or stocks owned predominantly by individuals.
The researchers were also able to compare the type of institutional ownership and how this affects stock returns and turnover. They found that stocks owned predominantly by mutual funds had higher turnover and more volatility than stocks owned predominantly by other types of institutions, such as pension funds.
Strickland said the results of this study contradict observers who believe individual investors drive stock market volatility because they are less sophisticated and more averse to risk than the professional money managers hired by institutional investors.
However, there are good reasons why professional money managers may panic more in volatile markets.
"Individual investors tend to have a long-term outlook, because they're investing for long-range goals such as retirement," Strickland said. "But money managers, especially those for mutual funds, are often evaluated quarter to quarter and they could lose their jobs if they aren't performing up to par."
The easiest way to protect themselves is to see what other money managers are doing and follow them, he said. "It's herding behavior. They figure that if their performance is not too different than other money managers, they are unlikely to be replaced."
These results suggest that investors in mutual funds and other institutions should pay attention to how their funds are managed.
"We should think about what our money managers are doing and how they are making their decisions," Strickland said. "Institutional investors are often taking a short-term view, which is not consistent with what individuals are often seeking."
Contact: Deon Strickland, (614) 292-1875; Strickland.34@osu.edu
Written by Jeff Grabmeier, (614) 292-8457; Grabmeier.1@osu.edu