Institutional Investors and Market Anomalies: Cui Bono?

The paper shows that index-tracking institutional investors do not exploit return predictability based on well-documented market anomalies related to publicly available accounting information. Instead, they purchase overpriced and sell underpriced stocks, earning negative and forgoing positive abnormal returns. Such seemingly negative stock-picking skills cannot be explained by price pressure or trade reversals, and are likely to be linked to incentives to minimize the tracking error relative to an index, rather than to maximize risk-adjusted returns. Hedge funds do not exhibit such a trading pattern; they earn positive abnormal returns while providing liquidity for the “wrong-side” trading of index-tracking institutional investors.