A NEW study has found significant evidence that hedge funds benefit from information they obtain in private meetings with company executives, adding to mounting research suggesting that selective access to management undermines regulators’ fair disclosure objectives.
The study’s authors, David H. Solomon, University of Southern California and Eugene F. Soltes, Harvard Business School, found that hedge funds make more informed trades after meeting privately with company management by boosting the size of their positions before periods of high returns and trimming their positions before periods of low returns.
They say their findings are “strongly significant and economically large” and “support the position that permitting private meetings between management and investors undermines regulators’ objective of wanting all investors to have equal access to information.”
Records obtained from NYSE company
The professors obtained detailed records of 935 private meetings over a 6-year period between 340 different institutional investors and executives of a mid-cap company listed on the New York Stock Exchange.
They note they had difficulty obtaining the information and had to guarantee anonymity to the company. Many investor relations officers they approached for data suggested that their firms did not maintain archival electronic records of these one-on-one interactions for “liability reasons,” while others maintained strict internal policies that prohibited distributing this information.
The study found that funds with more assets, greater turnover, closer physical proximity and greater holdings of the company were more likely to privately meet with management. Additionally, hedge funds were more likely to meet with management, which the authors say is consistent with sell-side analysts arranging meetings for their firms’ most profitable trading clients.
The average investor in the sample managed nearly $27 billion in equity assets while 21% of the investors had annual portfolio turnover of more than 100%. Fully 64% of the private meetings took place at investor conferences.
More than half of the investors (56%) met management only once during the sample period and 13% met at least once per year. Seven investors in the sample met at least 15 times, and of these the 4 most active were hedge funds and the remaining 3 were large buy-side investment firms.
“The regularity of these meetings for certain investors seems to indicate that these meetings offer more than just an opportunity to receive an introduction to management,” say the professors.
Meetings, not skill account for greater timing ability
When they analyzed the funds’ holdings after private meetings compared to similar funds that did not meet with management, Solomon and Soltes found that funds that meet with management are more likely to all buy the stock or all sell the stock in a given quarter.
“These correlations are strongly significant and economically large – we find that a meeting, on average, changes the probability of increasing a fund’s position by 21% on average,” they say.
And the information gleaned from management in private meetings appears to provide significant value to funds. The authors found that for funds that meet privately with management, a 10% increase in next quarter’s stock returns is associated with a 33% spike in the size of the investor’s position, relative to the trades of funds with similar characteristics.
The study also found that information provided by management rather than investor skill appears to explain funds’ greater timing ability. They found that while funds who meet management have greater timing ability after meetings, they do not appear to have better timing ability in periods when they do not meet management.
Hedge funds benefit more than others
An interesting finding from the study is that across the different types of investors who met with management, only hedge funds traded in the same direction, while the increased timing ability was strong for hedge funds and only weakly present for banks. Meanwhile, investment advisors and pension funds show no increase in timing ability or correlation of trades after meeting with management.
To explain this, Solomon and Soltes side with the theory that hedge funds may simply be “more sophisticated investors” rather than a hypothesis which has management providing different information to hedge funds than other investors.
They say that hedge funds may be better able to process the information in meetings, or may posses other information that, when put together with information they obtain from management, leads to more informed trades, what is often called “mosaic theory.”
Hedge funds “may also be more skillful in extracting useful information from management, such as by asking better questions,” although they add in a footnote that other studies have found that hedge funds are not more sophisticated than other investors.
One possible factor not explored in detail is that hedge funds may be more opportunistic traders who focus on shorter-term profitable trades while pension funds and mutual funds have longer-term investment horizons and are less likely to trade for short-term gains.
The researchers point out that company executives are not necessarily breaching any regulations when providing information to hedge funds or other investors in private meetings.
However, they note that their findings suggest that “the distinction between ‘material’ and ‘non‐material’ information is more subtle than typically envisaged in regulations.”
Mounting evidence, growing industry
The Solomon and Soltes study adds to others that have raised important questions about the propriety of private meetings between company management and institutional investors.
In May, a survey of 400 investors and analysts by PwC and the Rotterdam School of Management (RSM) found that 47% said they often receive material information in one-on-one meetings with companies.
And in August, IR Web Report reported about a study by Brian Bushee of the University of Pennsylvania, Michael Jung of New York University and Gregory Miller of the University of Michigan which found evidence that big investors benefit from information they glean in private meetings with company executives at major investment conferences.
Private meetings are often arranged by sell-side analysts for their most active trading clients, typically high-turnover hedge funds. A growing number of conferences are now advertised as “1×1” or “one-on-one” events, where hundreds of traders schedule one-on-one time with executives at a hotel. Other firms arrange bus tours for groups of clients to visit companies in specific locations. Seldom are these events made public.
Finding information about these events is made more difficult because many conference organizers block search engines from indexing their conference web pages.
Greenwich Associates recently estimated that US institutional traders are allocating around $1.4 billion in trading commissions to brokerage firms that set up private meetings for them with company executives.
Call to disclose private meetings
One concern is that companies may be devoting substantial resources to these meetings to the advantage of a few short-term traders and with no benefit to their long-term shareholders.
The average mega-cap company holds 459 one-on-one meetings annually, while the average micro-cap company holds 69 meetings, according to the October 2011 Global Trends In Investor Relations survey by BNY Mellon (see below table).
Companies also may be granting access to management out of fear of alienating sell-side analysts. On the flip-side, access to management may be used by some companies to curry favor with the sell-side and to influence stock recommendations.
While the studies certainly call into question whether current fair disclosure regulations are effective, Solomon and Soltes say in their paper that the “prohibition of all private meetings between management and investors may not be desirable, even if it were feasible.”
One suggestion put forward by Dr Erik Roelofsen, a researcher at RSM and also a director for PwC in the Netherlands, is to force companies to disclose the names of those they have talked to and when they did so, through their websites or other means.
His research found that 48% of analysts surveyed would support such a move, while 22% were opposed.