In particular, we examine how institutions modify their portfolios as stocks take on their anomaly-defining characteristics, and how anomaly returns relate to those actions. Our study conducts a detailed analysis of the relation between institutional investors and stock return anomalies, from the perspective of both asset management and asset pricing.
A skilled agent (investment manager) can be expected to exploit such an opportunity. Irrespective of whether anomalies represent mispricing or benchmarking errors, they provide a statistically reliable means of favorably biasing assessed performance against standard benchmarks. This analysis of how institutions’ holdings relate to stock return anomalies puts aside the general question of whether or not they are informed and focuses on a simpler question: do they exploit well-known sources of predictability in returns? That institutions fail to use such information is more than a little puzzling. 1 A recent study in this literature, Lewellen (2011), examines the aggregate holdings of institutional investors and finds that they essentially hold the market portfolio, with no discernible tilt to take advantage of well-known stock return anomalies. A longstanding debate in finance concerns whether institutional money managers are skilled investors.
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