New Developments in Long-Term Asset Management

Supported by the Norwegian Finance Initiative
Monika Piazzesi and Luis Viceira, Organizers
Second Annual Conference
New York, New York

May 19-20, 2017

Institutional Investors and Information Acquisition:

Implications for Asset Prices and Informational Efficiency

The importance of institutional investors in financial markets has grown steadily in recent decades. Institutional investors now hold a majority of U.S. equity and account for a majority of the transactions and trading volume. Relative performance concerns play a key role in the decisions of these investors, who are in the business of acquiring information and using that information for portfolio management. This paper attempts to demonstrate how the growth of assets under management by benchmarked institutions affects informational efficiency and asset prices in equilibrium.

Other Conference Papers

The Relevance of Broker Networks for Information Diffusion in the Stock Market, Marco Di Maggio, Francesco A. Franzoni, Amir Kermani, and Carlo Sommavilla

Asset Insulators, Gabriel Chodorow-Reich, Andra C. Ghent, and Valentin Haddad

Do Institutional Incentives Distort Asset Prices? Anton Lines

Chasing Private Information, Marcin T. Kacperczyk and Emiliano Pagnotta

ETF Arbitrage under Liquidity Mismatch, Kevin Pan and Yao Zeng

Replicating Private Equity, Erik Stafford

Efficiently Inefficient Markets for Assets and Asset Management, Nicolae Gârleanu and Lasse Heje Pedersen

< 2016 Conference Papers>
< 2018 Conference Papers>

Matthijs Breugem of the Frankfurt School of Finance and Management and Adrian Buss of INSEAD develop an equilibrium model with multiple risky assets to learn about. The model has two key features. First, a fraction of the institutional investors — the benchmarked investors — care not only about their own performance, but also about their performance relative to an index. This might be due to explicit reasons, for example, performance fees or a fund's "style," or implicit incentives, for instance, through the performance-flow relation. Second, the model allows for joint determination of the institutional investors' portfolio allocation and information choice, that is, investors optimally decide how much information to acquire.

The researchers highlight a novel economic channel through which benchmarking affects the portfolio allocation and information choice of institutional investors: Relative performance concerns lead to an increase in the effective, relative risk-aversion of a benchmarked institutional investor. In general, the optimal portfolio of a benchmarked institutional investor can be decomposed into three components: the optimal portfolio of a non-benchmarked investor; an information-insensitive hedging portfolio that implies a positive hedging demand for "index stocks" that are included in the benchmark portfolio; and a component capturing the change in the investor's risk attitude resulting from relative performance concerns.

As a direct consequence of the hedging demand for index stocks, a benchmarked institutional investor, on average, over-weights index stocks in his portfolio and under-weights non-index stocks, leading to excess demand for index stocks. Most important for the analysis, however, is that in the presence of benchmarking, the investor makes only smaller bets based on private information, or, formally, the sensitivity of his optimal portfolio composition to private information declines. For example, he less aggressively acquires shares of a stock following good news, and vice versa for bad news. This is due to the higher effective risk-aversion and the fact that the hedging demand is information-insensitive.

These changes in a benchmarked investor's portfolio decisions have a direct impact on his information choice. Because his trading is less sensitive to private information, the benchmarked investor values private information less. Hence, as his degree of benchmarking increases, an institutional investor acquires less precise private information.

As the figure shows, an increase in the fraction of benchmarked institutional investors leads to a drop in price informativeness for the index and the non-index stocks. Intuitively, an increase in the share of benchmarked investors implies a shift toward a group of investors who trade less aggressively and also acquire less information. Consequently, aggregate information acquisition declines and less information can be revealed through prices.


Less informative prices make investments into the stocks riskier because there is more uncertainty about their fundamentals, so that risk-averse investors reduce the price they are prepared to offer for shares. Thus, as benchmarked investors gain importance, the price of the non-index stocks declines. Due to the positive hedging demand for index stocks, their prices will always be higher than those of comparable non-index stocks, but might still decline in the size of the benchmarked institutions.

The decline in price informativeness naturally translates into a higher return volatility for all stocks in the economy. With less informative prices, private information gains importance, leading to a substantial out-performance of better-informed non-benchmarked investors.

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