How do Individual, Institutional, and Foreign Investors Win and Lose in Equity Trades? Evidence from Japan

1. How do Individual, Institutional, and Foreign Investors Win and Lose in Equity Trades? Evidence from Japan Kee-Hong Bae Korea University and Queen’s University Takeshi Yamada National University of Singapore Keiichi Ito Nomura Securities International, New York

2. Efficient markets • No investors consistently perform better (or worse) than others • On the other hand…. • Many studies have found different investor types have distinct patterns of trade • Research question: • How are these patterns related to performance?

3. Previous studies: Individuals (Institutions) have poor (good) performances • Barber-Odean (2000), Odean (1999) AER, Lee-Liu-Odean (2004) • Generally poor performance after trading cost • High turnover • Grinblatt-Keloharju (2000) JFE • Do not pick future winning stocks very well • Cohen (1999) • Individuals buy from institutions after price increases; bad timers • Cohen-Gompers-Vuolteenhao (2002) JFE • Institutions profit from individuals from underreaction of prices to good cash flow news

4. Previous studies:Domestic vs. foreign investors • Foreigners predicts future returns better than domestic investors • Seasholes (2000), Froot-O’Connell-Seasholes (2001) JFE, Froot-Ramadorai (2001), Karolyi (2002) PBFJ, Kamesaka-Nofsinger-Kawakita (2003) PBFJ • Domestic investors predicts future returns better • Dahlquist-Robertsson (2004) JBF • Foreigners do not have private information advantage • Choe-Kho-Stultz (2005) RFS • Dvorak (2005) JF • Foreigners buy more after large price hikes • Choe-Kho-Stultz (2005) RFS

5. Our paper • Examine all investor types across the market • Examine different aspects of trade performance • market timing • price spreads • trading interval • Examine how gains and losses shift among different investor types

6. Data:Tokyo Stock Exchange (1st Section) weekly trading data • Jan 1991-April 1999 (until trade were allowed off the exchange) • Buy and sell trade volume and value • Trade by different investor types • Individual investors, nonfinancial corporations, mutual funds, insurance companies, banks, proprietary trades of securities firms

7. Table 1.Sell price/Buy price Spread • Trade-weighted sell and buy price spreads • Individual 11.75%*** • Nonfonancial corp 5.22%*** • Mutual funds 0.50% • Insurance co -12.92%*** • Banks 32.16%*** • Foreigners -1.49%*** • Proprietary traders -0.16%

9. Table 2: Simple correlations • Correlations of net buys • Domestic investors vs. foreign investors • Nonprofessional investors vs. institutional investors (money managers) • Correlations with market returns • The net buy of foreign investors have strong positive correlation with past and future returns. • Domestic investors have negative correlations

11. Table 3: Seasonal patters of trade • Fiscal-year-end selling of domestic institutions • Fiscal-year-end buying of foreign investors (and individual investors)

14. Performance of Equity Trading • Trading gains = Net cash flows generated by trades • Net increase in portfolio holdings due to trade: not due to capital gains/losses as in conventional performance measures • Standardization • Number of shares: Buy and sell the same number of shares • Value of trades: net buy is zero yen over the observation period • Can compare across different investor types • Testable statistic

15. Overall net trading gains

16. Net gains from intertemporal price spreads

17. Net gains from market timing

18. Test • Null hypotheses • ∏=0, πs=0, πT=0 • Signed-rank test • Overlapping data (dependency) and seasonal patterns (periodicity) • Cannot use conventional standard error as it assumes independent data • Generate block bootstrap sample for testing

19. Table 4 Panel AAll months • The figures are in Yen that are generated from buy and sell trades with a median value of 100 yen each. • Individual investors • gain for short-term intervals from positive price spreads (due to selling the winners and holding onto the losers?) • but loses in long-term from poor market timing • Foreigners (and banks) • positive timing performance

21. Table 4 Panel BFiscal-year-end • Foreign investors gain more over the Jan-Mar period (especially from market timing) • Banks, non-financial corporations, insurance companies lose more during Jan-Mar • Foreigners take advantage of the selling of domestic institutions. • Selling might be due to year-end adjustment of portfolio and/or accounting reasons.

22. Table 5: Correlations of trading gains among the investor types • Net gains from price spreads • Shifts between nonprofessional investors (individual and nonfinancial corporations) and institutional investors (smart money managers) • Net gains from timing performance • Shifts between foreign and domestic investors • This effect dominates the overall result

24. Conclusion • Different investor types have different sources of equity trading gains and losses • Individual investors are poor in predicting future market returns but might gain in short-term trading by churning stocks • Foreign investors might not have better private information and are momentum traders (Brennan-Cao, 1997). Despite this fact, they are good in predicting future returns.

25. Conclusion • Different institutional background of the investors provides opportunity for trade. • Foreigners buy up from domestic institution at fiscal-year-end