Say you're pretty well off and have not one, but two, brokers who manage your investments. The first is a brisk, nimble type: every time an intriguing report or news item comes out, he calls, explains what happened and asks your permission to increase or reduce your position in the relevant stock.
The other broker is cool as an artik, practically unmovable, certainly not by the news. He hardly ever calls, even during quarterly-reports season. Sometimes you wonder if he's even connected to Internet or reads the paper.
Which broker is better? Which will achieve higher returns?
Most investors would choose the restless, fast-moving one. Information is the name of the game in the capital market, isn't it, and the first absorbs information much faster than the guy doing the sloth impression.
Not true, or at least that isn't true according to a series of U.S. studies published in recent months.
One study aspired to answer the question: Does frequent use of new information in the public domain improve returns? Does it achieve quite the opposite? The researchers collated information on mutual funds over ten years and more, processed the data and reached some surprising conclusions.
This is the broker for you
It turns out that the more use an investment manager makes of information in the public domain, such as financial statements or company actions or announcements, the worse his returns.
Managers who did not make much use of information in the public domain did significantly better.
An article in the last edition of Journal of Finance, a prestigious publication devoted to theory of financial economics, Marcin Kacperczyk and Amit Seru found that the best investment managers use less public information, therefore their portfolios are less sensitive to changes in information reaching the public domain.
That finding has fascinating implications. First of all, it shows that some managers really are better than others, and that the performance of the stars is related to their ability to create and exploit changes information that is not known to the general public. They obtain that information through research, talent or analytical ability; they process and forecast at levels that others can't emulate.
Secondly, Kacperczyk and Seru recommend using an index they developed to rank and reward investment managers. Remuneration based on returns alone can depend entirely on luck.
Third, the two found that their findings are not news to some institutions, including Goldman Sachs.
Too black and white, and too late
Then there is the tendency among papers and magazines to paint the outlines of companies in broad strokes, too broad, not to mention, too late.
The Economist reports this week about a study that looked at reports in American magazines such as Business Week, Forbes and Fortune, over 20 years.
They found a strong bias towards positive stories, and that the companies described in the articles tended to have outperformed the general index right before the stories came out, by an impressive 43%, on average. That's little surprise: magazines live by selling interesting stories, and will always prefer a nice story about a successful company (or a really mortifying flop).
But after the report, the situation changes. The companies that received negative coverage begin to flourish and beat the index by 12%. The ones that received plaudits slump towards average, outperforming the index by only 4%.
The researchers found that a magazine story on a successful company often marks the end of its streak. The Economist rules that people, including reporters, have a natural tendency to assume that what was, is what will be. If a company was doing well, it will continue to do so.
Do these studies mean that the information published on Internet and in the paper is gratuitous? Not at all. But investors must take into account that much of the new information being published today was already known to some players, and they may have been lurking in wait for you to buy in order to take profit.
"Fund Manager Use of Public Information" ,"New Evidence on Managerial Skills" - Marcin Kacperczyk and Amit Seru.
"Are Cover Stories Effective Contrarian Indicators?" - Tom Arnold, John H. Earl and David S. North.
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