Discussion of: "Who are the sentiment traders? Evidence from the cross-section of stock returns and demand"
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Discussion of:
“Who are the sentiment traders? Evidence from
the cross-section of stock returns and demand”
by Gennaro Bernile
Singapore Management University
ABFER May 26, 2014 - SingaporeAgenda
1. Short summary of the paper
2. My overall assessment
3. Comments
4. Recap and Conclusions
Discussion of “Who are the sentiment traders?” – by Bernile1.1 Summary of the Paper:
Context
• Two sentiment-related patterns in the cross-section of stock
returns (BW, 06, 07)
– More (less) volatile stocks have higher/positive (lower/negative)
sentiment-beta
• Contemporaneous returns are higher (lower) when sentiment changes are
high
– More (less) volatile stocks experience lower (higher) returns following
periods of high sentiment
• ‘Sentiment HP’ to explain this combo of patterns, under finite
D/S elasticities
– Sentiment traders’ demand shifts from safe to speculative stocks when
sentiment increases
– This pushes up (down) the price of speculative (safe) stocks when
sentiment increases, away from fundamentals
– Subsequent returns correct the relative mispricing
Discussion of “Who are the sentiment traders?” – by Bernile1.2 Summary of the Paper:
Where this paper comes in
• Dominant stance in literature: On average, Individual
(Institutional) Investors drive (absorb) sentiment trading
• With the power of “simple” questions, this paper asks:
Is it true in the data?
• To answer main question, first part of analysis:
Focus on time-series correlation between market
sentiment (shifts/levels) and institutional investors
demand (shifts/levels) for speculative-v-safe stocks
• Inferences about individual investors “by exclusion”
• Second part of analysis aims to understand why/mechanism
Discussion of “Who are the sentiment traders?” – by Bernile1.3 Summary of the Paper:
Empirical Findings and Takeaway
• Confirm sentiment-related patterns in the CS of returns
• Sentiment-related differences in relative demand (shocks and
levels) of spec-v-safe stocks
• Significant (time-series) positive correlation between institutional
(cross-sectional) demand shift for speculative-v-safe stocks and
contemp changes in market sentiment
• Dividend Premium covaries accordingly with institutional relative
demand shifts for Pay-v-NoPay stocks
• Why/mechanism: examine cross-institution variation in the main
findings (cross- and within-types) and within-institution mechanism
(flow- vs. active trading-driven demand)
• Main takeaway: Institutions (mainly MF and advisors) are the
sentiment (mainly active) traders
Discussion of “Who are the sentiment traders?” – by Bernile2. Summary of my assessment
• Contribution:
– Seemingly simple but profound question, with important implications for
how we think about ‘sentiment trading/traders’
– Answer matters to theorists and empiricists alike
– Main finding and takeaway are hard to dispute
– …maybe not quite sure about broader implications for the investment
industry (and its clients)…
• Presentation:
– Well written and organized, easy and pleasant read
– …not much to add…
• Implementation:
– Authors have and leverage notable expertise
– Tests are generally well-thought out and executed
– …some questions about: “timing” of sentiment trading; “who’s on the
other side” of a institutional demand shock…
– …would suggest exploiting more cross-institution dimensions for the
mechanism-part of the analysis
Discussion of “Who are the sentiment traders?” – by Bernile3.1 Comments: Timing – What is
‘quarterly’ trading?
• Quarterly Net Change in Institutional Ownership does not necessarily
reflect Institutional Quarterly Trading
• In the extreme, Zero Net Change could hide lots of trading
– Estimates of intra-quarter round-trip trading activity are quite large: 23% in
Puckett and Yan (2011); 20% in Elton, Gruber, Blake, Krasny, and Ozelge
(2010)
– Elton et al. (2010) and Elton, Gruber, and Blake (2010): with higher-
frequency (i.e., monthly) holdings data several inferences change (e.g.,
window-dressing, tax-loss selling, tournament behavior, and timing ability)
compared to using quarterly data
• Related but different, Pos or Neg Net Change could hide no trading
– More on this later
• What are the caveats, if any, using quarterly snapshots? Value
in using higher frequency data (e.g., ANcerno, NYSE CAUD)?
Discussion of “Who are the sentiment traders?” – by Bernile3.2 Comments: Timing – When is the
‘sentiment’ and when the ‘trading’?
• Analysis in the paper largely based on contemporaneous quarterly
changes in market sentiment and institutional ownership
• Related to my previous point (and bigger picture question later): a
quarter is a arguably long period relative to the potentially higher
frequency nature of trading
• Do intra-quarter lead-lag relations between ‘sentiment trading’
and ‘market sentiment dynamics’ matter for what we make of the
evidence based on quarterly snapshots?
– Doable with 13(f): Would it make sense to break up quarterly sentiment into
monthly and examine whether ‘market sentiment dynamics’ affect the
quarterly ‘sentiment trading’?
– Not with 13(f): Would it make sense examine lead-lag relations between
‘sentiment trading’ and ‘market sentiment dynamics’ intraquarter?
– Worth discussing what we can/cannot learn depending on frequency of
the analysis?
Discussion of “Who are the sentiment traders?” – by Bernile3.3 Comments: Who’s on the other side?
Does non-13(f)= investor?
• Related to my earlier point about Non-zero Changes in Ownership: does one
trader buying (selling) always require another trader selling (buying)?
• A non-zero ownership change may result from (non-flow related) “inaction”
by the investor in the event that firm issues or repurchases equity
– Not obvious that institutions and individuals have the same ability/incentives to ‘react’
to these events
– Seems this would break the ‘Institutional Net Demand’ = ‘- Individual Net Demand’, or
at least add a non-trading-related layer to the broader inferences
• In aggregate, both events likely related to sentiment systematically
– High (Low) Sentiment >> More Issuances (Repurchases)on this later
– In fact, they are directly included in the BW’s sentiment measure
• Does that relation also vary systematically with speculative nature of stock?
• IF SO, how does this affect the implementation of the tests and/or
interpretation of the results?
Discussion of “Who are the sentiment traders?” – by Bernile3.4 Comments: Who’s on the other side?
Does non-13(f)= uninformed investor?
• Even assuming that institutional ownership changes are in fact
the result of actual trading against another investor:
– Ex-ante, does it make sense to characterize the latter as the typical
uninformed retail investor that the general consensus suggests?
• Probably not…
– As authors recognize, non-13(f) registered institutions are part of it…
– …and so are corporate insiders (employees of all levels, founders,
controlling blockholders)…
– …and non-controlling, non-institutional blockholders
• Could they be the “liquidity traders” that are absorbing the
“institutional sentiment trading”? And if so, would we have
expected otherwise?
• Here: Is it worth trying to purge out non-retail holdings?
Discussion of “Who are the sentiment traders?” – by Bernile3.4 Comments: Who’s on the other side?
Does non-13(f)= uninformed investor?
So, how big of a deal can this ever be?
• From a project I started with Scott Bauguess at the SEC back in 2009 and have
recently picked up again…Blockholdings over time: Non-13(f) roughly 12+%
6,000 25% 10.0%
Blockholding as percent of total market
5,000 8.0%
20%
Percent of total market
4,000 6.0%
Value ($million)
15%
3,000 4.0%
10%
2,000 2.0%
5%
1,000 0.0%
06/97
06/98
06/99
06/00
06/01
06/02
06/03
06/04
06/05
06/06
06/07
06/08
06/09
0 0%
06/97
06/98
06/99
06/00
06/01
06/02
06/03
06/04
06/05
06/06
06/07
06/08
06/09
Investment Co Insider
Unclassified Private Co & partnerships
Total value of blocks % of CRSP corporate crossholdings
Value of all blocks Blocks by blockholder type3.5 Comments: IMO, big question
“is sentiment trading good/bad?”
• Characterization as being due to uninformed/irrational investors
would seem to suggest bad on all fronts:
– Lower price efficiency >> BAD for society, I suppose regardless
– IF due to uninformed & irrational behavior >> BAD for the investor (or clients
of the institutional investor…)
• BUT, does institutional ‘sentiment trading’ have to be driven by
uninformed & irrational behavior?
– Seem to suggest not when discussing the Hedge Fund-based test
– Why wouldn’t the “ride the bubble” logic apply more generally across
institutions?
• Related to my earlier question about “timing”:
– Playing a mental exercise based on Figure A.1: if the typical sentiment
trading institution buys Hi-Vol and sells Lo-Vol the first day of the quarter in
which a 1 St. Dev. Sentiment Change is expected to occur >>>
>>> Could earn 6% Risk-Adj Ret, doesn’t seem irrational to me
Discussion of “Who are the sentiment traders?” – by Bernile3.5 Comments: IMO, big question
“is sentiment trading good/bad?”
• As it stands, other than speculation in either direction, the paper does
not allow a convincing answer to the “good/bad” question
• Is it worth trying to give an answer to this (seemingly important)
question?
– I’d say yes, as it may speak to the ‘motives’ (i.e., the WHY) underlying the
aggregate patterns documented in the paper
• However, related to my earlier remark: providing a convincing answer
may not in fact be feasible using quarterly snapshots
– Higher Frequency would help somewhat
– Actual trading data would be best suited
• Is it something worth the investment in this paper? Not obvious
– But worth discussing, so not to come away with the (unsubstantiated!)
impression that institutional sentiment trading is certainly bad
Discussion of “Who are the sentiment traders?” – by Bernile3.6 Comments: More Leveraging of
Cross-Institution Differences
• Authors do some of that, which I liked because many related
questions came immediately to mind as I was reading through
the intro the very first time
• However, it is not obvious to me that the potentials are being
fully exploited
– I feel the HF- vs. MF-based tests are descriptive or indirect at best
– Same for the proportions of sentiment traders by institutional type (and
what are the VW proportions anyway?!)
– I like the “Strong Sentiment” vs. “Strong Liquidity” turnover analysis
• Broad questions:
– Stepping away from aggregates, are there Persistent Sentiment Trader types?
Can such a measure be devised – as opposed to Occasional Sentiment Trader
types?
– What explains institutions’ propensity to fall into either or none of these
categories?
– Tournament? Window-dressing? Timing? Flows vs. Active Investing?
Discussion of “Who are the sentiment traders?” – by Bernile4. Recap and Conclusions
• Who are the sentiment traders? At the quarterly frequency,
Institutions (mainly MF and advisors) are the sentiment
(mainly active) traders
• I really enjoyed reading the paper
– Important question and stimulating analysis/results
– Made me think a lot…
• While there may be room for some refinements, I have no
doubt this will be a high impact paper
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