Smart-Beta Institutional Ownership and Stock Return Anomalies

Abstract

I document a novel asset-pricing fact that the expected returns of 7 anomaly factors are lower among stocks with higher ownership share by smart-beta institutional investors who trade according to these anomalies. The factor-oriented demand of smart-beta investors contributes to lower price-of-risk or mispricing for the anomaly factors in equilibrium; and stocks have different levels of smart-beta demand from their owners due to investor heterogeneity and market segmentation. As a result, the return predictability of anomaly factors is decreasing in smart-beta institutional ownership in the cross-section of stocks. I provide persistent and robust empirical evidence for this relationship based on new measures of smart-beta factor demand at investor level. As the results show significant market segmentation across stocks, I further document that the market segmentation is driven by idiosyncratic volatility, benchmarking, and strategic considerations in smart-beta investing.

Keywords: Stock Return Anomalies, Smart-Beta Investing, Institutional Investors, Asset Demand System

JEL Classification: G11, G12, G23