Short Take

In China, Big Investors Have Brilliant Timing
― Or Do They Know Someone?

Avanidhar Subrahmanyam’s research scans a million brokerage accounts, finding the wealthy trade ahead of market-moving news

It takes money to make money, the old maxim goes. A recent study shows just how well that works for super-rich Chinese investors in the country's stock markets.

The study documents how a group of the wealthiest Chinese investors — those with portfolios ranked above the 99.5th percentile in size — were amazingly successful at trading over a period of nearly three years.

In that same period, trading results for investor groups below the 99.5th percentile didn't come close to the wealthiest investors' numbers, according to the study published in the Journal of Empirical Finance.

That left the authors — Nanjing University's Xindan Li and Honghai Yu, Shanghai Development Bank's Ziyan Geng and UCLA Anderson's Avanidhar Subrahmanyam — challenged to explain the huge disparity.

Their conclusion, in a nutshell: What matters is the quality of the information you're trading on. And the wealthiest Chinese investors seem to have access to very high-quality information about stocks. In the U.S., this access might well qualify as illegal insider trading. In China, it doesn't.

For the study, a major Chinese brokerage gave the authors daily data on trades and account holdings from January 2007 to October 2009 for nearly one million investor accounts, without divulging clients' names. Those accounts were divided into four subsets based on asset size: zero to 50th percentile, 50th to 90th, 90th to 99.5th, and the final 0.5 percent. Respectively, the subsets were classified as small, middle, big and super investors.

When the authors tallied trading performance over the full period, the differences between the wealthiest investors and the rest were stark. The super investors achieved average risk-adjusted gross returns of 16.8 percent annualized from trading. By contrast, those returns for the big, middle and small investor cohorts were 6.3 percent, 1.4 percent and negative 2.0 percent, respectively.

The study also discerned a particular trading scheme among super investors: they were very good at buying shares of Chinese companies just ahead of the firms' announcements of large stock dividend payments. Typically, the announcements drove the stocks up — after which the super investors tended to sell.

Three other peculiarities of the super investors stood out. First, their portfolios often were concentrated in relatively few stocks; the investors didn't bother to seek to lower risk by increasing diversification. Second, they focused on stocks of companies based in their own hometowns or regions. And third, "The super investors who trade the most actively earn the highest risk-adjusted net returns, while the more other investors trade, the more they lose," the paper says.

Could it simply be that the wealthiest investors are the smartest traders? The authors allow it's possible that the super investors "got rich because of their higher cognitive ability, which translates into better trading performance."

But they add that "our work suggests that [super investors'] wealth might indeed provide access to privileged information" about stocks, and, specifically, that of companies based in their own backyards.

Under U.S. law, investing based on tips of private information about a company can be construed as illegal insider trading. But under Chinese law, while the tipster of such information could be prosecuted, a person who receives the information and trades on it technically doesn't commit a crime.

Li, X., Geng, Z., Subrahmanyam, A., & Yu, H. (2017). Do wealthy investors have an informational advantage? Journal of Empirical Finance, 44, 1–18. doi: 10.1016/j.jempfin.2017.07.001

Avanidhar Subrahmanyam

Distinguished Professor of Finance, Goldyne and Irwin Hearsh Chair in Money and Banking

Avanidhar (Subra) Subrahmanyam is an expert in stock market activity and behavioral finance. He is known for his pathbreaking research in the use of psychological principles to explain stock price movements and has published numerous articles in leading peer-reviewed finance and economics journals. Subrahmanyam's current research interests range from the relationship between the trading environment of a firm's stock and the firm's cost of capital to behavioral theories for asset price behavior and empirical determinants of the cross-section of equity returns.

 

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