Keeping a close eye on the best ideas and conviction trades of fund managers can offer huge insight but these aren’t the only institutional signals that private investors can use to their advantage. While the level of institutional ownership in a stock generally has limited predictive use on its own, when changes occur in the ownership make up - either through new buying or selling - it can be a sign that sentiment is changing and the share price could be on the move.
Researchers have spent decades studying the influence that institutional holders have on the prices of shares that they trade. A lot of this work has found that there’s a strong positive connection between changes in ownership and share price returns measured over the same period. Work by US researchers (Nofsinger et al.) in the late 1990s found that, on average, the 10% of stocks with the largest increase in institutional ownership outperformed the 10% of stocks with the largest decrease by more than 31% per year.
How institutional interest affects prices
For many in the investment community the focus of attention has now turned to why prices respond to changes in institutional ownership. The problem here, however, is that fund managers, both in the UK and US, are only required to report changes to their holdings on a quarterly basis, which has made it difficult to pinpoint what the precise reasons are.
One mooted factor is that so-called positive feedback strategies are at play, with funds actually responding to price movements and buying stocks with positive price momentum already behind them. In contrast, there are some who think that fund managers are adept at forecasting quarterly stock returns and that they lead the market (rather than lag it) by buying stocks ahead of price movement.
There are also some direct reasons why changing ownership can affect prices. Among them are suggestions that that fund managers, with an army of researchers at their disposal, are simply better skilled at interpreting stock information and timing their purchases accordingly. Not only that but by trading in the market they are conveying information that others may copy. And in stocks where liquidity may be low or the supply of shares constrained, institutional trading can force prices higher.
What to look for in institutional trading
In a detailed 2006 study of all these factors (Sias et al.),…
