Double or Nothing: Patterns of Equity Fund Holdings and Transactions

Abstract

Prospect theory of Kahneman and Tversky (1979) suggests that traders will typically lock in gains and gamble on losses. In extreme situations such behavior can lead to significant downside risk for fund investors. Weisman (2002) uses the term informationless investing to describe this behavior, and argues that these strategies are peculiar to the asset management industry in general, and the hedge fund industry in particular and that these strategies can produce the appearance of return enhancement without necessarily providing any value to an investor. We devise a simple procedure to determine whether a given pattern of trading is consistent with informationless investing and apply it to a unique database of daily transactions and holdings of a set of thirty nine successful Australian equity managers. While this pattern of trading does seem to characterize the portfolios of some of the largest funds in Australia, this phenomenon is limited to positions taken in individual securities within large and well diversified funds. For this reason the negative consequences for fund investors appear to be limited.

Keywords: Prospect Theory, Disposition Effect, Risk management; Performance evaluation; Window dressing

JEL Classification: G23