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Informed trading, liquidity provision, and stock selection by mutual funds

We show that the stock selection ability of a fund manager can be decomposed into two components: "informed trading" and "liquidity provision." As information loses value over time, informed trading tends to be liquidity-absorbing. We conjecture that value enhancing informed trading is more likely in stocks during times when they are associated with more information events. In contrast, liquidity provision is more likely to add value for stocks associated with few information events and little adverse selection risk. We identify times when there are more information events associated with a stock by its Probability of Informed Trading (PIN, Easley et. al., 1996) measure and information asymmetry component of the spread (Madhavan et. al., 1997). We provide empirical support for our conjecture using quarterly mutual fund holdings data for the period from 1983 to 2004. We find that the informed trading component is relatively more important for mutual funds with a growth oriented investment style whereas liquidity provision is more important for funds with more of an income orientation. Further, the informed trading component of the selection ability of a mutual fund exhibits greater persistence over time.

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  • "We show that the stock selection ability of a fund manager can be decomposed into two components: "informed trading" and "liquidity provision." As information loses value over time, informed trading tends to be liquidity-absorbing. We conjecture that value enhancing informed trading is more likely in stocks during times when they are associated with more information events. In contrast, liquidity provision is more likely to add value for stocks associated with few information events and little adverse selection risk. We identify times when there are more information events associated with a stock by its Probability of Informed Trading (PIN, Easley et. al., 1996) measure and information asymmetry component of the spread (Madhavan et. al., 1997). We provide empirical support for our conjecture using quarterly mutual fund holdings data for the period from 1983 to 2004. We find that the informed trading component is relatively more important for mutual funds with a growth oriented investment style whereas liquidity provision is more important for funds with more of an income orientation. Further, the informed trading component of the selection ability of a mutual fund exhibits greater persistence over time."
  • "We show that the stock selection ability of a fund manager can be decomposed into two components: "informed trading" and "liquidity provision." As information loses value over time, informed trading tends to be liquidity-absorbing. We conjecture that value enhancing informed trading is more likely in stocks during times when they are associated with more information events. In contrast, liquidity provision is more likely to add value for stocks associated with few information events and little adverse selection risk. We identify times when there are more information events associated with a stock by its Probability of Informed Trading (PIN, Easley et. al., 1996) measure and information asymmetry component of the spread (Madhavan et. al., 1997). We provide empirical support for our conjecture using quarterly mutual fund holdings data for the period from 1983 to 2004. We find that the informed trading component is relatively more important for mutual funds with a growth oriented investment style whereas liquidity provision is more important for funds with more of an income orientation. Further, the informed trading component of the selection ability of a mutual fund exhibits greater persistence over time."@en
  • "We show that a mutual fund's "stock selection skill" computed using the Daniel, Grinblatt, Titman and Wermers (1997) procedure can be decomposed into additional components that include impatient "informed trading" and "liquidity provision," thereby helping us understand how a fund creates value. We validate our method by verifying that liquidity provision is the dominant component of selection skill for Dimensional Fund Advisors U.S. Micro Cap fund, as observed by Keim (1999). Index funds lose on liquidity absorbing trades, since they pay the price impact on trades triggered by index rebalancing, inflows and redemptions. Consistent with the view that a mutual fund manager with superior stock selection ability is more likely to benefit from trading in stocks affected by information events, we find that funds trading such stocks exhibit superior performance that is more likely to persist. Further, such superior performance comes mostly from impatient informed trading. We also find that informed trading is more important for growth-oriented funds while liquidity provision is more important for younger funds with income orientation."
  • "We show that a mutual fund's "stock selection skill" computed using the Daniel, Grinblatt, Titman and Wermers (1997) procedure can be decomposed into additional components that include impatient "informed trading" and "liquidity provision," thereby helping us understand how a fund creates value. We validate our method by verifying that liquidity provision is the dominant component of selection skill for Dimensional Fund Advisors U.S. Micro Cap fund, as observed by Keim (1999). Index funds lose on liquidity absorbing trades, since they pay the price impact on trades triggered by index rebalancing, inflows and redemptions. Consistent with the view that a mutual fund manager with superior stock selection ability is more likely to benefit from trading in stocks affected by information events, we find that funds trading such stocks exhibit superior performance that is more likely to persist. Further, such superior performance comes mostly from impatient informed trading. We also find that informed trading is more important for growth-oriented funds while liquidity provision is more important for younger funds with income orientation."@en

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  • "Informed trading, liquidity provision, and stock selection by mutual funds"
  • "Informed trading, liquidity provision, and stock selection by mutual funds"@en
  • "Informed Trading, Liquidity Provision, and Stock Selection by Mutual Funds"@en
  • "Informed Trading, Liquidity Provision, and Stock Selection by Mutual Funds"
  • "Informed trading, liquidity provision and stock selection by mutual funds"@en

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