Playing the Market:Turnover of Institutional

Ownership and Stock Returns

Valentin DimitrovRutgers University

Vladimir GatchevUCF

February 5, 2010

Institutional Investors

Institutional investors play a dominant role in U.S. equity markets

According to the Conference Board, in 2006 the market value of total institutional equity holdings was $12.9 trillion, accounting for 66.3% of total equity

Institutions are active traders Boehmer and Kelley (2009) report that institutional

investors account for the majority of trading volume on NYSE

We find that institutional investors turn over 37% of their ownership per quarter

There is substantial variation in institutional turnover rates across stocks (0% to 100% per quarter)

Motivation

What are the implications of turnover rates by institutions for stock prices?

Share turnover rates and disagreement Karpoff (1986) Harris and Raviv (1993)

Disagreement and stock valuation Miller (1977)

A more comprehensive theory Harrison and Kreps (1978) Scheinkman and Xiong (2003)

Scheinkman and Xiong (2003)

Two classes of investors disagree about fundamentals

The relative valuations of the two classes fluctuate over time

When valuations cross, the optimists buy the shares from the pessimists, leading to share turnover

With short-sales constraints, share ownership comes with an option to sell to more optimistic investors

Share prices include a premium for the option to sell Investors buying the shares pay that premium Investors selling the shares require that premium

In equilibrium, higher turnover rates are accompanied by a higher premium in prices – investors “Pay to Play”

Do Institutions Pay to Play?

Is high turnover of ownership by institutions associated with a premium in stock prices?

If, on average, institutions expect to profit from trading, a premium in prices may exist

Would institutions’ expectations of trading profits depend on who they trade with?

Individuals Commonly held view is that individuals are less informed that

institutions If institutions hold that view, they will expect to make profits when

trading with individuals Other institutions

If institutions believe that other institutions are also well informed, then they may not expect to make profits from trading with other institutions

Hypotheses Turnover of institutional ownership is negatively related to

future stock returns

The negative relation between turnover of institutional ownership and future stock returns is:

More pronounced when turnover is due to trading of institutions and individuals than when turnover is due to trading among institutions

The negative relation between turnover of institutional ownership and future stock returns is more pronounced for firms in which differences of opinion are more likely to be high:

High return volatility stocks High total trading activity stocks High growth opportunities stocks

Related Literature Institutional ownership

Gompers and Metrick (2001) Yan and Zhang (2009)

Changes in institutional ownership Nofsinger and Sias (1999) Cohen, Gompers, Vuolteenaho (2002) Cai and Zheng (2004) Campbell, Ramadorai, Schwartz (2009)

Institutional herding Wermers (1999) Sias (2004) Dasgupta, Prat, Verardo (2009)

Changes in breadth of ownership Chen, Hong, Stein (2002)

Snapshot of Results (1) Turnover of institutional ownership is

negatively related to future returns Based on 10 portfolios, the hedge return

for the two extreme portfolios is 8.6% The relation is due to trading of institutions

with individuals Robust to controls for size, B/M, past

returns, level and change of institutional ownership, return volatility, and overall trading activity

Snapshot of Results (2) Results are more pronounced for

stocks with high overall trading activity 15.0% (vs 2.1%) hedge return

stocks with high stock return volatility 10.2% (vs 0.3%) hedge return

stocks with low B/M 13.6% (vs 2.5%) hedge return

Not subsumed by additional ownership-related variables change in breadth of institutional ownership persistence in institutional buying

Sample and Turnover Measures

Main sample from CDA/Spectrum database Common stocks between 1983:Q4 to 2007:Q4 A total of 416,384 observations for an average of 4,293 per

quarter A minimum of 3,263 and a maximum of 5,765 stocks per quarter

Turnover of institutional ownership Due to total trading (1):

Absolute value of quarterly change in shares held by each institution, summed up over all institutions, divided by average shares held by all institutions, over the past 8 quarters

Due to trading of institutions with individuals (2):Absolute value of quarterly change in shares held by all institutions, divided by average shares held by all institutions over the past 8 quarters

Due to trading among institutions: (1) minus (2)

Additional Variables Additional data sources

CRSP, Compustat Additional variables

Stock returns for the past 24- and 12-months Stock returns for the future 3-, 6-, and 12-months Market capitalization of equity Book-to-market of equity Stock return volatility for the past 24 months Total share turnover for the past 24 months Level of institutional ownership Average change in institutional ownership for the past 8

quarters Change in breadth of ownership (Chen, Hong, and Stein (2002)) Persistence in institutional buying (Dasgupta, Prat, Verardo

(2009))

Summary Statistics (1)Panel A: Summary statistics (416,384 observations)

Variable Mean Min 25th

percentile Median

75th percentile

Max

InstTurnTotal 0.367 0.000 0.237 0.333 0.461 1.087

InstTurnIndiv 0.159 0.000 0.058 0.106 0.200 0.906

InstTurnInst 0.207 0.000 0.108 0.201 0.291 0.557

InstOwn 0.342 0.000 0.114 0.295 0.539 1.000

InstOwn 0.006 – 0.270 – 0.002 0.003 0.012 0.414

MktCap 1.724 0.001 0.038 0.135 0.600 602.433

BM 0.701 0.010 0.330 0.566 0.884 9.905

Turnover 0.062 0.000 0.021 0.043 0.081 0.326

Volatility 0.025 0.000 0.007 0.014 0.029 0.218

Return-24 0.356 – 0.998 – 0.227 0.169 0.652 4.885

Return-12 0.165 – 0.991 – 0.191 0.073 0.371 2.981

Return12 0.143 – 1.000 – 0.217 0.061 0.357 53.663

Summary Statistics (2)Panel B: Time-series means of correlation coefficients

InstTurnTotal InstTurnIndiv InstTurnInst

InstTurnIndiv 0.743 – 0.121

InstTurnInst 0.564 – 0.121

InstOwn – 0.102 – 0.463 0.415

InstOwn 0.135 0.054 0.140

ln(MktCap) – 0.058 – 0.413 0.422

ln(BM) – 0.203 – 0.087 – 0.196

ln(Turnover) 0.392 – 0.051 0.645

ln(Volatility) 0.385 0.350 0.142

Return-24 0.085 0.063 0.054

Return-12 0.023 0.054 – 0.029

Return12 – 0.062 – 0.054 – 0.026

Future 12-month Hedge Returns Based on Total Turnover of Institutional Ownership

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

1984 1985 1987 1988 1990 1991 1993 1994 1996 1997 1999 2000 2002 2003 2005 2006 2008

Hed

ge re

turn

Portfolio Formation Date

Future 12-month Hedge Returns Based on Turnover of Institutions with Individuals

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

1984 1985 1987 1988 1990 1991 1993 1994 1996 1997 1999 2000 2002 2003 2005 2006 2008

Hed

ge re

turn

Portfolio Formation Date

Future 12-month Hedge Returns Based on Turnover Among Institutions

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

1984 1985 1987 1988 1990 1991 1993 1994 1996 1997 1999 2000 2002 2003 2005 2006 2008

Hed

ge re

turn

Portfolio Formation Date

Portfolio Analysis (1)Panel A: Means of portfolio stock returns -- portfolios based on InstTurnTotal

Port InstTurnTotal Return-24 Return-12 Return3 Return6 Return12

1 0.106 0.261 0.145 0.038 0.078 0.165

2 0.190 0.274 0.146 0.039 0.080 0.162

3 0.238 0.291 0.146 0.039 0.078 0.156

4 0.276 0.303 0.151 0.037 0.076 0.155

5 0.312 0.319 0.150 0.037 0.073 0.152

6 0.351 0.342 0.164 0.035 0.070 0.148

7 0.397 0.364 0.162 0.031 0.064 0.132

8 0.455 0.410 0.174 0.030 0.062 0.131

9 0.541 0.472 0.179 0.022 0.046 0.100

10 0.769 0.531 0.210 0.016 0.033 0.079

P10 – P1 0.663 0.270 0.065 – 0.022 – 0.046 – 0.086 (t-stat) (4.3) (1.7) (– 2.2) (– 2.6) (– 2.6)

Portfolio Analysis (2)Panel B: Means of portfolio stock returns -- portfolios based on InstTurnIndiv

Port InstTurnIndiv Return-24 Return-12 Return3 Return6 Return12

1 0.028 0.313 0.145 0.036 0.073 0.152

2 0.046 0.309 0.141 0.038 0.077 0.153

3 0.061 0.293 0.136 0.038 0.078 0.159

4 0.077 0.291 0.140 0.037 0.076 0.157

5 0.097 0.308 0.141 0.038 0.078 0.162

6 0.120 0.327 0.147 0.034 0.068 0.147

7 0.152 0.355 0.151 0.033 0.067 0.139

8 0.196 0.393 0.160 0.028 0.059 0.126

9 0.272 0.464 0.200 0.023 0.046 0.101

10 0.527 0.514 0.264 0.019 0.039 0.084

P10 – P1 0.499 0.201 0.119 – 0.017 – 0.035 – 0.067 (t-stat) (2.8) (3.4) (– 1.8) (– 2.1) (– 2.4)

Portfolio Analysis (3)Panel C: Means of portfolio stock returns -- portfolios based on InstTurnInst

Port InstTurnInst Return-24 Return-12 Return3 Return6 Return12

1 0.014 0.290 0.172 0.033 0.066 0.132

2 0.061 0.307 0.174 0.036 0.074 0.158

3 0.107 0.306 0.162 0.038 0.076 0.156

4 0.147 0.317 0.162 0.034 0.070 0.149

5 0.183 0.331 0.164 0.033 0.067 0.140

6 0.216 0.356 0.169 0.036 0.072 0.146

7 0.250 0.381 0.175 0.032 0.066 0.136

8 0.289 0.402 0.174 0.032 0.063 0.130

9 0.340 0.435 0.164 0.027 0.057 0.120

10 0.443 0.442 0.110 0.023 0.049 0.114

P10 – P1 0.429 0.152 – 0.062 – 0.010 – 0.018 – 0.018 (t-stat) (3.2) (– 2.0) (– 1.1) (– 1.3) (– 0.6)

Regression Analysis:Base Specification

Variable Model 1 Model 2 Model 3 Model 4

ln(MktCap) 0.001 – 0.002 0.002 – 0.002 (0.2) (– 0.4) (0.4) (– 0.4) ln(BM) 0.059 0.059 0.063 0.059 (7.0) (6.4) (7.0) (6.9) InstOwn 0.001 – 0.023 0.008 – 0.022 (0.04) (– 1.4) (0.4) (– 1.2) InstTurnTotal – 0.087 (– 2.5) InstTurnIndiv – 0.149 – 0.149 (– 5.0) (– 5.4) InstTurnInst – 0.020 – 0.003 (– 0.3) (– 0.1) Adjusted R2 0.59% 0.62% 0.54% 0.62%

Regression Analysis:Additional Controls (1)Panel A: Dependent variable is future 12-month return (Return12)

Variable Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

InstTurnIndiv – 0.149 – 0.141 – 0.137 – 0.158 – 0.126 – 0.120 (– 5.4) (– 5.1) (– 5.6) (– 6.7) (– 5.4) (– 5.7) InstTurnInst – 0.003 – 0.004 0.025 0.008 0.081 0.107 (– 0.1) (– 0.1) (0.6) (0.1) (2.0) (3.1) InstOwn – 0.330 – 0.538

(– 2.0) (– 3.6) ln(Volatility) – 0.010 – 0.007 (– 0.8) (– 0.6) Return-24 – 0.013 – 0.010 (– 1.5) (– 1.2) Return-12 0.036 0.039 (2.0) (2.3) ln(Turnover) – 0.021 – 0.020 (– 1.9) (– 2.8) Adjusted R2 0.62% 0.63% 0.63% 0.67% 0.66% 0.74%

Regression Analysis:Additional Controls (2)Panel B: Dependent variable is future 3-month return (Return3)

Variable Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

InstTurnIndiv – 0.029 – 0.029 – 0.027 – 0.041 – 0.023 – 0.030 (– 2.1) (– 2.1) (– 2.5) (– 3.6) (– 2.3) (– 3.6) InstTurnInst – 0.022 – 0.022 – 0.016 – 0.010 0.002 0.019 (– 0.8) (– 0.8) (– 0.9) (– 0.4) (0.1) (1.2) InstOwn 0.007 – 0.142

(0.1) (– 2.0) ln(Volatility) – 0.002 – 0.004 (– 0.4) (– 0.7) Return-24 – 0.004 – 0.004 (– 1.1) (– 0.9) Return-12 0.027 0.028 (2.9) (3.1) ln(Turnover) – 0.006 – 0.005 (– 1.1) (– 1.4) Adjusted R2 0.26% 0.26% 0.26% 0.49% 0.28% 0.53%

Conditional Portfolio Analysis (1)

Panel A: Future 12-month returns for portfolios based on Turnover and InstTurnIndiv

Turnover portfolio

InstTurnIndiv portfolio

1 2 3 4 5

1 0.163 0.165 0.141 0.146 0.141

2 0.167 0.157 0.137 0.143 0.147

3 0.161 0.177 0.145 0.140 0.153

4 0.171 0.169 0.166 0.160 0.139

5 0.162 0.184 0.160 0.136 0.111

6 0.163 0.176 0.160 0.137 0.092

7 0.167 0.189 0.149 0.113 0.075

8 0.160 0.169 0.165 0.104 0.074

9 0.137 0.169 0.133 0.071 0.029

10 0.141 0.136 0.093 0.064 – 0.009

P10 – P1 – 0.021 – 0.029 – 0.048 – 0.082 – 0.150 (t-stat) (– 1.5) (– 1.2) (– 1.2) (– 1.7) (– 3.5)

Conditional Portfolio Analysis (2)

Panel B: Future 12-month returns for portfolios based on Volatility and InstTurnIndiv

Volatility portfolio

InstTurnIndiv Portfolio

1 2 3 4 5

1 0.155 0.141 0.154 0.152 0.164

2 0.154 0.150 0.148 0.171 0.137

3 0.146 0.155 0.166 0.172 0.110

4 0.154 0.147 0.147 0.172 0.100

5 0.152 0.154 0.151 0.137 0.084

6 0.154 0.155 0.166 0.137 0.097

7 0.155 0.155 0.167 0.123 0.068

8 0.162 0.144 0.166 0.115 0.070

9 0.162 0.158 0.130 0.096 0.056

10 0.153 0.151 0.131 0.091 0.063

P10 – P1 – 0.003 0.009 – 0.023 – 0.061 – 0.102 (t-stat) (– 0.1) (0.5) (– 1.2) (– 3.0) (– 3.2)

Conditional Portfolio Analysis (3)

Panel C: Future 12-month returns for portfolios based on BM and InstTurnIndiv

BM portfolio

InstTurnIndiv Portfolio

1 2 3 4 5

1 0.122 0.140 0.154 0.154 0.186

2 0.126 0.139 0.149 0.162 0.172

3 0.119 0.135 0.157 0.177 0.190

4 0.107 0.141 0.154 0.162 0.195

5 0.060 0.159 0.148 0.183 0.201

6 0.056 0.138 0.159 0.175 0.192

7 0.041 0.124 0.146 0.168 0.198

8 0.018 0.098 0.155 0.168 0.199

9 – 0.010 0.089 0.131 0.156 0.209

10 – 0.014 0.090 0.116 0.146 0.162

P10 – P1 – 0.136 – 0.051 – 0.038 – 0.008 – 0.025 (t-stat) (– 3.2) (– 1.4) (– 1.6) (– 0.3) (– 1.1)

Conditional Regression Analysis

Model 1 Model 2 Model 3

InstTurnIndiv – 0.418 – 0.317 – 0.103 (– 4.4) (– 2.8) (– 4.0) InstTurnInst 0.071 0.016 – 0.003 (1.8) (0.4) (– 0.1) ln(BM) 0.055 0.055 0.045 (7.5) (8.8) (5.4) ln(Turnover) – 0.004 (– 0.5) ln(Volatility) – 0.002 (– 0.1) InstTurnIndiv × ln(Turnover) – 0.081 (– 3.5) InstTurnIndiv × ln(Volatility) – 0.049 (– 1.8) InstTurnIndiv × ln(BM) 0.065 (3.5) Adjusted R2 0.70% 0.65% 0.64%

Changes in Turnover and Returns

2IndivtInstTurn portfolio

InstTurnIndiv Portfolio

1 2 3 4 5 P5 – P1 (t-stat)

1 0.317 0.315 0.303 0.412 0.617 0.300 (2.3) [330] [192] [104] [62] [41] 2 0.301 0.297 0.344 0.416 0.561 0.261 (3.0) [191] [210] [169] [108] [50] 3 0.281 0.289 0.327 0.421 0.555 0.274 (3.3) [109] [168] [193] [164] [94] 4 0.235 0.226 0.256 0.330 0.492 0.257 (3.5) [64] [110] [166] [208] [181] 5 0.136 0.174 0.165 0.205 0.379 0.243 (4.2) [34] [49] [96] [187] [363] P5 – P1 – 0.181 – 0.141 – 0.138 – 0.206 – 0.238 (t-stat) (– 5.1) (– 4.3) (– 5.5) (– 4.6) (– 2.1)

Institutional OwnershipPanel A: Means of future 12-month returns for portfolios based on InstOwn and InstTurnIndiv

InstOwn portfolio

InstTurnIndiv portfolio

1 2 3 4 5

1 0.160 0.175 0.159 0.147 0.142

2 0.152 0.165 0.156 0.148 0.150

3 0.143 0.169 0.178 0.149 0.138

4 0.132 0.175 0.156 0.155 0.147

5 0.130 0.158 0.166 0.159 0.147

6 0.108 0.163 0.160 0.165 0.151

7 0.090 0.149 0.143 0.156 0.146

8 0.105 0.136 0.129 0.150 0.143

9 0.091 0.111 0.113 0.123 0.115

10 0.062 0.083 0.082 0.091 0.083

P10 – P1 – 0.098 – 0.092 – 0.078 – 0.056 – 0.059 (t-stat) (– 3.5) (– 3.1) (– 3.0) (– 1.7) (– 2.3)

Change in Institutional Ownership

Panel B: Means of future 12-month returns for portfolios based on InstOwn and InstTurnIndiv

InstOwn portfolio

InstTurnIndiv portfolio

1 2 3 4 5

1 0.149 0.155 0.158 0.142 0.139

2 0.169 0.162 0.152 0.149 0.151

3 0.171 0.160 0.147 0.149 0.151

4 0.183 0.153 0.158 0.156 0.141

5 0.186 0.155 0.155 0.155 0.122

6 0.172 0.143 0.162 0.148 0.110

7 0.160 0.145 0.148 0.147 0.099

8 0.135 0.140 0.130 0.131 0.099

9 0.154 0.120 0.096 0.108 0.063

10 0.124 0.090 0.069 0.064 0.073

P10 – P1 – 0.025 – 0.065 – 0.089 – 0.078 – 0.066 (t-stat) (– 0.8) (– 2.2) (– 2.9) (– 2.3) (– 2.6)

Change in Breadth of Ownership

Panel C: Means of future 12-month returns for portfolios based on Breadth and InstTurnIndiv

Breadth portfolio

InstTurnIndiv portfolio

1 2 3 4 5

1 0.138 0.156 0.155 0.157 0.152

2 0.135 0.147 0.169 0.158 0.154

3 0.151 0.160 0.161 0.159 0.163

4 0.143 0.166 0.178 0.156 0.169

5 0.138 0.155 0.157 0.168 0.173

6 0.146 0.155 0.155 0.150 0.164

7 0.131 0.135 0.153 0.142 0.134

8 0.102 0.118 0.124 0.123 0.136

9 0.102 0.104 0.109 0.098 0.115

10 0.047 0.063 0.090 0.099 0.092

P10 – P1 – 0.092 – 0.093 – 0.065 – 0.059 – 0.059 (t-stat) (– 2.7) (– 3.5) (– 2.6) (– 2.0) (– 1.7)

PersistencePanel D: Means of future 12-month returns for portfolios based on Persistence and InstTurnIndiv

Persistence portfolio

InstTurnIndiv portfolio

1 2 3 4 5

1 0.159 0.162 0.149 0.152 0.134

2 0.186 0.153 0.151 0.150 0.135

3 0.172 0.161 0.158 0.148 0.139

4 0.174 0.161 0.159 0.159 0.126

5 0.191 0.164 0.163 0.151 0.142

6 0.184 0.155 0.157 0.146 0.104

7 0.157 0.160 0.144 0.140 0.104

8 0.124 0.133 0.131 0.110 0.094

9 0.139 0.108 0.112 0.109 0.050

10 0.135 0.087 0.095 0.086 0.058

P10 – P1 – 0.025 – 0.075 – 0.054 – 0.066 – 0.077 (t-stat) (– 0.6) (– 2.2) (– 1.8) (– 2.5) (– 2.4)

Robustness Measuring turnover rates

6 quarters, 4 quarters Dollars vs shares

Robust across different time periods 1983-1997; 2000-2007

Other controls 8 lags of change in institutional ownership

Data selection Winsorizing future returns; truncating

variables Using stocks below $1/share

Conclusions (1)

High turnover of institutional ownership is associated with a premium in stock prices

The premium is driven by trading of institutions with individuals

The premium is more pronounced for: stocks with high stock return volatility stocks with high overall trading activity stocks with low B/M

Conclusions (2)

Results consistent with disagreement-based models

Harrison and Kreps (1978) Scheinkman and Xiong (2003)

Risk-based explanations? Liquidity? Adverse selection costs?

What differences between institutions and individuals drive our findings?

Predictable individual investor sentiment Agency issues of institutional investors