buy and sell timing decisions by mutual fund managers
DESCRIPTION
√. Buy and Sell Timing Decisions by Mutual Fund Managers. Rajiv D. Banker Janice Chen Fox School of Business Temple University. Theme of the Paper. √. Job security and compensation incentives imply that active fund managers have superior ability to time the market in buy or sell trades - PowerPoint PPT PresentationTRANSCRIPT
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Buy and Sell Timing Decisions by Mutual Fund Managers
Rajiv D. BankerJanice Chen
Fox School of BusinessTemple University
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Theme of the Paper• Job security and compensation incentives imply
that active fund managers have superior ability to time the market in buy or sell trades
• Psychological biases, such as disposition or endowment effects, may inhibit efficient timing
• Data on 18 fund managers at one firm spanning one year (2005)
• We find fund managers exhibit good buy and sell timing ability
• Actual trading strategy outperforms both momentum and contrarian strategies
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Mutual Funds
• A mutual fund is a trust that pools the savings of a number of investors
• In end 2007, the combined assets of mutual funds in the U.S. were $12 trillion
• In early 2008, the worldwide value of all mutual funds totaled more than $26 trillion
• Mutual fund companies competed vigorously to attract investor funds
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Stock Picking Ability
Market Timing Ability
Fama (1972)
Wermers (1997) Jiang et al. (2007)
Bollen and Busse (2001)Grinblatt and Titman (1989, 1993)
Fund Manager Performance
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Principal Hypothesis
Fund managers have the ability to time their buy and sell trades efficiently
Timing ability is critical for fund managers:• High liquidity and frequent trading activities• Replacement of less successful fund managers• High investment turnover rate• Bonuses based on fund performance
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Measures of Timing AbilityBased on only fund-level data
• Treynor and Mazuy (1966)
• Henriksson and Merton (1981)
• Jiang et al. (2007) Artificial timing bias: time-varying parameter problem
pmpmppp RcRR 2**
pmpmppp RcRR ),0max(**
),cov()()()( 111 mtptmtptpt rrEErE
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Behavioral Finance Studies• Psychological biases inhibit performance
• Overconfidence explains reduction in investors’ performance due to excessive trading (Barber and Odean 2000, 2001, 2002)
• Fund managers exhibit herding behavior (Grinblatt et al. 1995)
• Disposition effect (Shefrin and Statman 1985)
• Endowment effect (Thaler, 1980)
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Prospect Theory Kahneman and Tversky 1979
VALUE
LOSSES
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Disposition Effect
• Disposition effect is an implication of prospect theory (Kahneman and Tversky 1979) applied to investment decisions
• Disposition effect reflects the tendency of investors to sell winners too early and hold on to losers too long (Shefrin and Statman 1985)
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Disposition Effects on Trading
• Individual investors sell winners early and hold on to losers (Odean 1998)
• Professional managers also exhibit disposition bias (Grinblatt and Keloharju 2001, Scherbina and Jin 2005)
• Disposition effect may lead to inefficient timing decisions for buy and sell trades
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Endowment Effect
• People often demand much more to give up an object
• Tversky and Kahneman (1991) attribute this phenomenon to loss aversion (tendency to strongly prefer avoiding losses than acquiring gains)
• Endowment effect may lead to inefficient timing decisions for buy and sell trades
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Alternative Trading Strategies
• Contrarian Strategy Buying losers and selling winners (De Bondt and
Thaler 1985, 1987)
• Momentum Strategy Buying winners and selling losers (Jegadeesh
and Titman, 1993)
• If fund managers are good at timing their trades, they should outperform these simple strategies
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Hypothesis 2
• The actual trading strategy of fund managers outperforms both the contrarian strategy and the momentum strategy trading the same stocks
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Sample Data• Transaction-based datasets• 11,906 buy transactions 8,465 sell transactions• Each transaction has trading volume
(quantity), market value, cumulative excess returns (3, 6 month pre-trade returns and 3, 6 month post-trade returns).
• There are 18 fund managers • Our transaction dataset is proprietary and
spans one calendar year 2005
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Four Time Periods for Annualized Excess Returns
All 4 time periods are calibrated relative to the date of trade
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Types of Traded Stocks
Buy Transactions Sell Transactions
Number % Number %
Growth 5,399 45% 4,019 47%
Value 6,203 52% 4,171 49%
Large cap 7,929 67% 5,483 65%
Small cap 3,673 31% 2,707 32%
Over-weighted 10,194 86% 6,050 71%
Under-weighted 1,712 14% 2,402 28%
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Empirical Results• Buy sample:
The medians of annualized excess returns are significantly negative in pre-trade periods while significantly positive in post-trade periods
• Sell sample:
The medians of annualized excess returns are significantly positive in pre-trade periods while significantly negative in a post-trade period
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Buy TransactionsMedian Excess Returns
-6 -3 +3
-7
-6
-5
-4
-3
-2
-1
0
1
2
med
ian
exce
ss re
turn
s -6 -3 0 +3 +6
-2.17
-5.90
1.44
0.31
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Sell Transactions Median Excess Returns
-6 -3
-4
-2
0
2
4
6
8
10
med
ian
exce
ss r
etur
ns
-6 -3 0 +3 +6
4.05
8.78
-1.98
1.48
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Buy Sub-Sample AnalysisMedian Excess Returns
Pre6-3 Pre3-0 Post0-3 Post3-6
Full Sample -2.17** -5.90*** 1.44*** 0.31***
Growth 0.39*** -0.35*** 3.42*** -1.18***
Value -4.18*** -9.44*** -0.13*** 0.97***
Large Cap -2.45 -5.83*** 1.92*** -1.92
Small Cap -0.34*** -4.87*** 0.27*** 4.37***
Overweighted -2.54 -6.31*** 1.56*** 0.15***
Underweighted 0.02*** -3.54 0.59*** 1.19***
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Sell Sub-Sample AnalysisMedian Excess Returns
Pre6-3 Pre3-0 Post0-3 Post3-6
Full Sample 4.05*** 8.78*** -1.98*** 1.48***
Growth 10.94*** 14.76*** -2.66 2.86***
Value -0.26*** 2.52*** -1.26*** 0.29***
Large Cap 3.64*** 6.08*** -2.25** 0.19***
Small Cap 5.87*** 15.89*** -1.31*** 4.14***
Overweighted 4.78*** 12.27*** -2.15*** 2.43***
Underweighted 2.20*** 2.19*** -1.41 -0.54***
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Paired TestsPre-Trade Minus Post-Trade Median Excess Returns
Buy Sample Sell Sample
Post0-3 Post3-6 Post0-3 Post3-6
Pre3-0 -5.23*** -4.53*** 9.67*** 7.63***
Pre6-3 -2.49*** -1.99*** 5.55*** 2.70***
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Buy Sample Paired TestsPre-Trade Minus Post-Trade Median Excess Returns
Buy
-6
-5
-4
-3
-2
-1
0
Post0-3 Post0-3
Pre3-0
Pre6-3
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Sell Sample Paired TestsPre-Trade Minus Post-Trade Median Excess Returns
sell
0
2
4
6
8
10
12
Post0-3 Post0-3
Pre3-0
Pre6-3
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Growth vs. ValuePaired Test
Buy Sample Sell Sample
Growth Post0-3 Post3-6 Post0-3 Post3-6
Pre3-0 -0.82*** 2.90*** 16.00*** 12.06***
Pre6-3 -1.82 3.96*** 12.99*** 7.69***
Buy Sample Sell Sample
Value Post0-3 Post3-6 Post0-3 Post3-6
Pre3-0 -8.63*** -9.99*** 5.26*** 1.71***
Pre6-3 -2.57*** -5.46*** -0.54 -0.82
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Large Cap vs. Small CapPaired Test
Buy Sample Sell Sample
Large Cap Post0-3 Post3-6 Post0-3 Post3-6
Pre3-0 -6.57*** -1.87*** 7.19*** 4.90***
Pre6-3 -2.50*** 0.15 4.68*** 3.09***
Buy Sample Sell Sample
Small Cap Post0-3 Post3-6 Post0-3 Post3-6
Pre3-0 -1.33** -9.41*** 17.02*** 12.82***
Pre6-3 -1.71 -5.36*** 7.93*** 2.70***
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Overweighted vs. UnderweightedPaired Test
Buy Sample Sell Sample
Overweighted Post0-3 Post3-6 Post0-3 Post3-6
Pre3-0 -5.88*** -4.77*** 12.70*** 10.84***
Pre6-3 -3.28*** -2.90*** 6.89*** 2.71***
Buy Sample Sell Sample
Underweighted Post0-3 Post3-6 Post0-3 Post3-6
Pre3-0 -1.03 -1.90 4.02*** 1.27**
Pre6-3 1.64 2.48 2.47*** 2.69*
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Momentum and Contrarian Strategies
• Winners are stocks with positive excess returns in 3 months preceding trade date
• Losers are stocks with negative excess returns in 3 months preceding trade date
• Momentum strategy mimicking portfolios buy winners and sell losers
• Contrarian strategy mimicking portfolios buy losers and sell winners
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Comparison with Momentum Strategy
Excess returns of actual strategy – Excess returns of momentum strategy
Mean Median
Diff_Ret Mean p-value Median p-value
Buy Sample 1.53 0.03 1.57 0.015
Sell Sample -2.13 0.03 -2.16 0.001
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Comparison with Contrarian Strategy
Excess returns of actual strategy – Excess returns of contrarian strategy
Mean Median
Diff_Ret Mean p-value Median p-value
Buy Sample 1.37 0.075 1.26 0.03
Sell Sample -1.97 0.01 -1.85 0.003
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Robustness Check
• Results survive when performance of trading strategies is evaluated relative to distribution of simulated excess returns (Kothari and Warner, 2001) drawn from the CRSP population of stocks
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Conclusion
• Managers have a good market timing ability to buy stocks at a low price and sell at a high price
• Fund managers are not overly influenced by psychological biases such as the endowment effect or the disposition effect
• Fund managers outperform both the momentum strategy and the contrarian strategy
• Caveat: Data for only one company for one year
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