Which Investors Matter for Equity Valuations and Expected Returns?

Abstract

We develop and estimate a characteristics-based demand system for financial assets to quantify the impact of changes in demand of various investors on asset prices and investors’ wealth. We apply the model to understand the impact of the market trend from active to passive investing on asset prices and price informativeness. We find that there is a nontrivial impact on valuations, yet a small impact on price informa- tiveness. To understand the mechanism, we develop a new investor-level measure of price informativeness and show that there is no systematic relation between changes in institutional flows from active to passive managers and and how informed investors are about future fundamentals. We also explore the impact of a shift in demand for green firms, either for a subset of investors as a result of climate-related regulations or for a broad group of institutional investors due to overall increased awareness. This shift in demand benefits long-term investors such as pension funds and insurance companies, banks, and passive investment advisors at the expense of hedge funds and small-active investment advisors.