Apr 22, 2012

Investment Herding Risk

What was suspected, has now been proved:

Investment Herding Exists!

Dutch Pension Funds are active Traders
In a 2011 research document called "Herd behavior and trading of Dutch pension funds", researchers Rubbaniy, Lelyveld and Verschoor of the Dutch Erasmus University in Rotterdam, provided evidence that repudiates the popular belief that - in specific - Dutch pension funds are long-term passive institutional traders.

De facto Dutch pension funds are active traders and trade about 8.5%  of their portfolio on a monthly basis!

Conclusions
Main conclusions of Rubbaniy (et al.) are:
  • Significant feedback trading strategies, both momentum and contrarian
  • Robust herding behavior in investments of Dutch pension funds
    Overall (LSV) herding level of 8.14% (significant at 1% level !!)
    On average if 100 PFs are active in the same security in the same month, there are 8.14 more PFs trading on the same side of the market than what would be expected under null hypothesis of random selection of securities.
  • Herding asymmetry in buying and selling of securities
    Across asset classes there is a higher degree of herding in less-risky assets.
  • Recent financial crises have a positive impact on both turnover and herding while it negatively affects feedback trading.


Explanations
Possible explanations of these herding effects are:
  • Possibly outsourcing of portfolio management and small PFs imitation of large PFs’ lead to the same kind of asset allocation strategy.
  • Many small Dutch PFs often hire the same large and reputed asset management firms for their portfolio management and are likely to have same asset allocation of their portfolios. 
  • Even if they do their own portfolio management, small Dutch PFs may mimic the investment behavior of large PFs - a widespread belief about the small investors - and thus, add to (LSV) herding measure.

Remarks
Let's conclude with some remarks....

  • Dangerous Big Brother Hedge
    Although large PFs (investors) have some 'economics of scale' and budget for experimenting on a small scale with (alternative) non-conventional investments, their investment strategy probably strongly differs from a small PF, as liabilities, sponsor obligations and pension benefits conditions are often are fund specific. 

    Therefore, following a large PF asset strategy as a small PF, is extremely dangerous and will eventually not turn out to be the 'big brother hedge' the fund was aiming at.
     
  • Unfounded First Mover Risk
    Key question remains if all this herding, hedging and active trading results in an outperformance above a long term sustainable asset-location strategy.

    Probably not. But although investors pretend tot act on a rational basis, in reality irrational and conformist behavior take the upper-hand. Small investors often don't dare to formulate a unique fund specific asset allocation strategy because of 'first mover risk'.

Keep care and formulate yur own specif pension fund strategic asset mix!

Related Links & Sources
 - "Herd behaviour and trading of Dutch pension funds" (2011, PDF)
 - Momentum or Contrarian Investment Strategies:
    Evidence from Dutch Institutional Investors (2011)
- Momentum and Contrarian Stock-Market Indices

By Maggid on 4/22/2012 05:03:00 PM
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2 comments:

  1. Marko LehtonenMay 9, 2012 at 2:29 PM

    I see how safe to have an investment here and the strategy is strong so no worry about negatives things to happen.

    ReplyDelete
  2. UnknownOctober 29, 2012 at 9:27 AM

    I like looking at the data. Very infornmative actually.
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    ReplyDelete

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