Investors need an information advantage in order to beat the market, according to a study by a leading academic.
Meziane Lasfer, a professor of finance at Cass Business School, looked at the share price movements of AstraZeneca and Pfizer before, during and after their very public takeover negotiations. He focused on the stocks’ daily excess returns, which he calculated as the returns from each firm minus the market return from the FTSE 100 for AstraZeneca and the S&P 500 for Pfizer.
Lasfer, who also served as an external consultant at the Financial Services Authority from 2007-09, identified three distinct phases in these returns.
The first is the period from May to November 2013, when there was no hint of a deal. Lasfer found that through this time the direction of both share prices was ‘relatively random’. AstraZeneca produced a daily excess return of 0.01% and Pfizer of 0.04% during these months, with a positive correlation between the two stocks.
The second phase runs from November to April 2014, which spans the first contact between AstraZeneca and Pfizer – which was not disclosed to the market at the time.
‘This is the most interesting period,’ Lasfer said. First, the stocks were negatively correlated in these months – for Lasfer this represents ‘an ideal dream of fund managers’.
Pfizer’s daily excess returns were minus 0.07% through the period, while AstraZeneca’s were positive at 0.22%. ‘This indicates that an informed investor could short Pfizer and go long on AstraZeneca and generate excess returns of plus 31.2%,’ Lasfer said.
The third period is the single day of 28 April, when AstraZeneca and Pfizer made their announcements to the market. Both share prices climbed, with AstraZeneca’s spiking 14%, as textbooks would suggest given the mooted synergies and premium offer.
‘If an informed investor knew about – or predicted correctly – this takeover in November 2013, the total excess returns she would have accumulated would be a stunning 48.28%,’ Lasfer said.
‘What can this case teach us?’ he asked in conclusion.
‘First, when the news is announced, shareholders cannot beat the market. It seems that the UK market is efficient as, in the post-announcement period from 28 April to 11 June 2014, the share prices appear to reflect more the probability of the bid going through and the potential synergies the bid is going to generate.’
He added that the market also seemed to be operating efficiently before there was any news, in the months before the initial discussions in November 2013.
However, he argued that ‘the efficient market hypothesis does not seem to hold in the second period’, once the private talks began in November. Even discounting the jump on the day of the public statement in April, clued-in buyers could have produced returns 30% above the index.
‘Thus even though the UK market is relatively efficient, some informed investors appear to be able to beat it and realise some transfer of wealth from the uninformed investors,’ he said.
‘Overall, the only way of beating the market is to have information that others do not have. As in anything in life, information is the name of the game.’
So how well informed is the average active manager? Data from Citywire indicates that any information advantage they possess fades over time.
The average fund in the UK All Companies sector has beaten the FTSE All Share by roughly the same margin over one, three and five years: by 11% to 9%, 33% to 30%, and 95% to 93% respectively.
But for a full decade, the average manager significantly underperforms, returning 124% compared with the index’s 135% – and even that flatters active management, given survivorship bias.
Equally, those average numbers mask a wide range of returns.
The best manager in the sector over the past three years, Citywire AAA-rated Martin Walker through his Invesco Perpetual UK Aggressive fund, has recorded more than double the average return with 73.5%.
Whether it is easier for a fund picker to identify sources of such excess returns than a stock picker is a subject for a different study.