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In Shanghai, it seems, the dumb money is very dumb indeed — and there’s a lot of it.
This first bit comes via our Tilted colleague (and the original Alphavillain) Paul Murphy. In December the CSRC, China’s financial markets regulator, and the OECD released a joint paper on the legal infrastructure of the country’s public markets.
S&P reviewed the paper, and included this in its report:
Chinese institutional investors are actively looking for investment opportunities in Brazil and Africa, leaving the bulk of the local trading to Chinese private individuals who constitute approximately 45% of the players on the two mainland stock exchanges.
Institutional investors must register with CSRC as qualified foreign investors (QFI), and all QFIs together hold only about 1% of the almost US$4 trillion (Reuters) A-share market capitalization in China.
So foreign investors make up a negligible fraction of the A-shares market, with retail investors accounting for nearly half the total participants and “the bulk” of local trading. That’s a bit vague, but it’s enough for this post to simply acknowledge that retail money accounts for a disproportionately large share of trading in Chinese stock markets.
Something to keep in mind as you read the conclusions of this new paper by James Choi, Li Jin, and Hongjun Yan. The three authors studied the returns of every investor in the A-shares market on the Shanghai Stock Exchange from 1996-2007. They found that when the fraction of retail investors with long positions in a stock increased, that particular stock was more likely to underperform for the next month.
The relationship was generally reversed for institutional investors, with an increase in their investment amounts leading to higher returns — though these findings were a bit less robust than those for retail investors.
Because retail investors are more likely to be “noise traders”, write the authors, more of them piling into a stock is probably a sign of changing market sentiment rather than new, favourable information being priced in.
We’re not nearly as comfortable as the authors seem to be in saying that these conclusions have predictive powers across other markets — or even for future returns on the Shanghai Stock Exchange. But if you’re a retail investor in China and see more of your kind piling into a certain stock, you might want to give it a second thought.
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