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Unseasoned equity issues and institutional trading : an empirical analysis Vandemaele, Sigrid N.


In the first part of this study, the focus is on the long-term performance of two IPO samples with issue years 1990 and 1991, respectively. The performance of particular IPO portfolios has been studied in a series of articles. There seems to be a consensus that investors in IPOs earn low returns. For the sample of 70 firms with issue year 1990, I find evidence of underperformance consistent with Ritter’s (1991) findings: the three-year buy-and-hold return on a portfolio formed by investing $1 in each IPO at the end of the first listing date is 23.2%, compared to an equivalent return for the index of 45.8% and to an equivalent return for the matched firm portfolio of 48.6%. In addition to the standard buy-and-hold analysis, I show that this underperformance disappears if the IPO portfolio is rebalanced to equal weights on each anniversary of the issue date. I conclude that the difference in performance of a buy-and-hold portfolio and of a portfolio with yearly rebalancing could be due to overreaction by investors in IPOs : after a certain period, poor performers tend to be undervalued (possibly due to overreaction) and/or good performers tend to be overvalued (possibly due to overreaction). Rebalancing to equal weight is equivalent to putting more weight in past losers and less weight in past winners. If there is a tendency to mean reversion, the rebalancing effect on the portfolio return will be positive. In contrast, however, for the sample of 224 IPOs of 1991, I do not find evidence of underperformance. Neither is there evidence of a positive rebalancing effect on the IPO portfolio return. In the second part of the study, I focus on the trading behavior of institutions in the aggregate in IPO markets. In particular, I examine how the quarterly changes in institutional holdings relate to quarterly past, current and future returns. I find evidence of a strong positive feedback trading strategy. The positive association between current adjusted performance and changes in holdings could be evidence of a rational update in expectations by institutions on the less informed side of the market. The pattern of buying current winners and selling current losers could be strengthened by a concern about reputation or over the ‘fiduciary duty’-aspect of a money managers’ job. The positive association between past adjusted performance and changes in institutional holdings could be driven by a belief that past trends are likely to continue. However, there is evidence of at least part of it being the result of an intertemporal association between money managers’ trades : managers, observing the holdings of their colleagues at the end of the quarter, don’t want to miss the boat and buy a positive stake the next quarter. The evidence of a positive association between current (past) positive adjusted performance and changes in institutional holdings is stronger than has been documented by Lakonishok et al (1992) for the average common stock institutions trade in. The observed trading patterns could be destabilizing in nature and could result in an undervaluation of past underperformers and an overvaluation of past overperformers. To attribute the finding of a positive rebalancing effect on the return of the IPO portfolio to institutional trading behavior in IPOs, we should have an idea of the importance of institutions’ trading in IPO markets. The percentage of IPO shares outstanding that institutions hold at the end of the first and second post-issue year may give an indication that their presence in IPO markets could be important. The results, however, do not allow us to make any conclusive statement about a possible causal relationship between institutional IPO trading and the evidence of overreaction in IPO prices.

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