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Does Smart Money Move Markets?

The authors split equity investors into two groups, one of “smart money” institutional investors and the other of individual investors. Using quarterly data, they examine how aggregate ownership flows between the two groups are related to stock returns. Except in one case, increases in institutional ownership are associated with positive returns, and reductions in institutional ownership with negative returns, and the positive relationship between institutional ownership flows and returns is not explained by within-quarter momentum trading. These findings are consistent with the belief that institutional investors play a price-setting leadership role in the equity markets. The exception to the positive association between institutional ownership flows and returns is for small-capitalization stocks; increases in institutional ownership of small-capitalization stocks that were prior losers are associated with negative returns (concentrated in the fourth quarter). This different return pattern for small-capitalization stocks is interpreted as consistent with institutions buying stocks at price discounts from individuals who are systematically selling to establish tax-deductible capital losses.