‘Where are the customers’ yachts?’ ask the critics of active management. It may be a fair point, but perhaps ‘Where are the fund managers’ jets?’ would be a more pertinent question.
The value of a private plane to an investor is one indirect conclusion of a forthcoming paper by Brian Bushee of the University of Pennsylvania’s Wharton School, Joseph Gerakos of the Tuck School of Business at Dartmouth College and Lian Fen Lee of Boston College’s Carroll School of Management, writing in the Journal of Accounting & Economics.
The trio analyzed data from a Freedom of Information request about corporate jet flights, in an attempt to parse likely trips by executives to financial hubs, where they would attend investor roadshows. Of course, Regulation Fair Disclosure prohibits companies from disclosing material information such as earnings forecasts at these meetings, but investors are able to obtain views from corporate management to help them build a ‘mosaic’ of information.
The jet set
But does attending these meetings in person really help investors? Bushee, Gerakos and Lee identified a 4% relative increase in absolute size-adjusted returns for investors after these roadshows, compared with the performance of the company’s shares after other uses of the corporate jet.
‘The economic magnitudes are relatively small because private meetings are measured with noise and only a small subset of investors meet with managers at these meetings,’ the authors noted. ‘However, the fact that we statistically detect a market reaction due to a small subset of investors updating their private information – while other investors are unaware of the meetings – suggests that those investors believe that they receive an information advantage through
Matching up the corporations, the cities their jets visited and the institutional investors in those cities, Bushee, Gerakos and Lee also discovered that the roadshows were associated with more buying and selling of the traveling managers’ stocks by the local fund groups. Furthermore, this tended to generate ‘significant positive trading gains’ for the investors when the presenting company was more complex – with their intangible assets serving as a proxy for this – and when private interactions between the managers and investors had previously been infrequent.
‘Overall, the statistical significance and consistency of the results suggest that these meetings are an important information event for the participating investors, raising the regulatory question of whether non-participants are significantly disadvantaged by the real-time unobservability of corporate jet flight patterns,’ Bushee, Gerakos and Lee concluded.
However, those excluded from the roadshows need not lament their loneliness; they still have the internet. For investment purposes this can be used to access another source of information: corporations’ mandatory public filings.
This is the subject of a new study by Jonathan Kalodimos of Oregon State University and Brian Gibbons and Peter Iliev of Pennsylvania State University. The authors traced analysts’ use of the SEC’s Edgar repository – which is anonymous but can still be linked to employers’ IP addresses – to examine whether such fundamental research added any value.
Encouragingly, it did. After controlling for factors such as experience and company size – which have already been shown to affect the accuracy of an analyst’s forecasts – conducting fundamental research on Edgar before updating an earnings forecast reduced their error rate by 3.6% relative to their peers.
Stock recommendations made when the analyst had read an Edgar filing over the preceding five days were also associated with cumulative abnormal returns that were 72 basis points higher.
‘We provide direct evidence that analyst forecasts backed by fundamental research are associated with more accurate predictions of earnings,’ Kalodimos, Iliev and Gibbons summarized. ‘Furthermore, we establish a strong relationship between recommendations backed by fundamental research and positive abnormal returns.’
While this specific paper focused on sell-side analysts, it is clearly applicable to the buy side as well. Taken together, the two studies reinforce the importance of due diligence – qualitative and quantitative, in person and online – when investing. Most portfolio managers will naturally insist that research is a crucial component of their process, but fund buyers should confirm that they are indeed attending roadshows and reading 10-K reports.