Swedroe: The Media Effect

For individual investors, the financial media plays an important role in disseminating information on securities markets. For example, a 2000 survey by the SEC found that more than 40 percent of individual investors rely heavily on information derived from mass media when choosing their mutual fund investments.

David Solomon, Eugene Soltes and Denis Sosyura—authors of the study “Winners in the Spotlight: Media Coverage of Fund Holdings as a Driver of Flows,” which was published in the July 2014 issue of the Journal of Financial Economics—sought to determine if individuals use information from the media to make better investment decisions.

The authors studied the role of media coverage in investors’ capital allocations to mutual funds and found that it does have a significant effect on how they allocate capital. The following is a summary of their findings:

• Investors’ capital flows respond to holdings’ past returns, but only if these holdings were covered in widely circulated newspapers in the preceding quarter.
• Investors allocate significantly more (less) capital to funds holding media-covered stocks with high (low) past returns.
• The effect on flows is driven more by rewarding funds that hold media-covered winners than penalizing funds that hold media-covered losers.
• Fund flows react strongly to holdings’ returns in the periods after disclosure, but not before. In other words, the effect of media-covered holdings on fund flows is driven by the disclosure of those holdings.
• Investors’ reaction to media-covered holdings is driven by media coverage of stocks rather than media coverage of mutual funds.
• When comparing returns to risk-adjusted benchmarks, there’s no evidence that shows investors tend to receive higher returns by investing in funds with media-covered past winners. However, they likely incur substantial transaction costs from fund chasing.

The authors concluded that media coverage influences investor behavior in a way that exacerbates behavioral biases, such as chasing recent performance. So it seems that mutual funds have been correct to engage in the well-documented behavior of “window dressing.” Window dressing is when funds buy recent winners just before reporting dates because they believe investors will assume the fund was skillful in identifying the past winners ex-ante.

Professional Investors And The Media

That finding raises an interesting question, and one that Lily Fang and Joel Peress, tried to answer in their study, “Does Media Coverage of Stocks Affect Mutual Funds’ Trading and Performance?” The paper was published in the September 2014 issue of the Review of Financial Studies. You wouldn’t think that professional investors would be subject to the same mistakes made by individual investors.

For example, individual investors might consider what they read in the financial media to be not just information, but value-relevant information. Professionals, on the other hand, shouldn’t make such mistakes. They know that mass media coverage isn’t conveying genuine news to the market. In other words, professionals know they’re unlikely to generate superior returns by reacting to articles in The Wall Street Journal.

The authors collected comprehensive media coverage data from LexisNexis for all NYSE stocks and 500 randomly selected Nasdaq stocks for the period 1993 through 2002. The study included articles published about the sample stocks in four major daily newspapers with nationwide circulation: USA Today, The Wall Street Journal, The New York Times and The Washington Post.

Together, those publications account for 11 percent of the average weekday newspaper circulation in the U.S., and are likely to be representative of most of the coverage of the corporate sector. The following is a summary of the authors’ findings:

• Stocks receiving media coverage are more heavily bought by funds in the aggregate. Buying in high-coverage stocks is about twice as intense as in low-coverage stocks and three times as intense in no-coverage stocks.
• Funds exhibit heterogeneity in their propensity to buy media-covered stocks, and this propensity is negatively related to future fund performance.
• Funds in the highest-propensity decile underperform funds in the lowest-propensity decile by 1.5 percentage points to 2 percentage points per year.
• These results do not extend to fund sells, likely due to funds’ inability to sell short.
• Funds with high propensity to buy media-coverage stocks do so persistently.

It seems that institutional investors are subject to the same problems with limited attention that individuals are. They make the same mistakes, and such behavior harms their investment performance. Maybe fund managers aren’t the “masters of the universe” they want investors to believe they are. They’re human, just like the rest of us, and subject to the same human foibles.

Larry Swedroe is the director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country.