Are retail investors better at picking stocks than hedge funds? Bank of America says the answer is yes.

Wall Street pros have been known to take a haughty attitude toward retailers. But as it happens, the “dumb money” — a phrase occasionally associated with more than a dab of taunting mom-and-pop investors — might be smarter than think the pros.

At least, that’s the conclusion — or rather, one of many conclusions — that a team of quantitative and equity strategists at Bank of America Global Research, led by Savita Subramanian, come to in a new annual introduction to quantitative research entitled “Everything You wanted to know about Quant.”

The work, which is nearly 300 pages long, is packed with charts and graphs as the team takes an analytical approach to validate (or reject) conventional investment wisdom on a range of topics.

“Smart” vs. “Stupid” money

One of the first “myths” addressed in the report is whether retail investor interest in a stock serves as a reliable “counter-indicator” — that is, whether rising retail investor interest is a sign that a stock is going up could be heading for a difficult phase.

Much to the chagrin of the hedge fund industry, the B. of A. strategists found this not entirely true. Instead, they found that inflows from individual investors were, on average, better predictors of performance than inflows from hedge funds – albeit marginally.

“In fact, returns after periods of retail inflow have outperformed and returns after retail sales have underperformed. And retail flows were slightly better positive indicators than hedge fund flows,” the analysts wrote.

The team’s data-backed analysis found that stocks with strong retail inflows tended to outperform their benchmarks by 1.1 percentage point over the following four weeks, compared with a 1 percentage point outperformance for stocks with hedge fund inflows.

Source: Bank of America

And when markets fall, high retail ownership stocks tend to outperform low retail ownership stocks.

Value vs Growth

Another topic explored in the B. of A. report is the historical performance of value and growth stocks relative to their benchmarks (the S&P 500 index for US stocks). SPX).

Long-term, for example, Russell 1000 Value Index RLV,
has outperformed the Russell 1000 Growth Index. But during “late cycle” periods, the trend reverses and growth outperforms. The B. of A. team found that while value stocks have outperformed since 1978, growth stocks tended to outperform from 2007 through mid-2020.

On an annualized basis, growth has outpaced value in six of the past seven years.


Source: Bank of America

Value stocks also tended to show their best performance in the first 12 months of a tightening cycle. The Federal Reserve began raising interest rates in March, and most economists expect the central bank to continue raising rates for the rest of the year and into 2023.


Source: Bank of America

Will corporate buybacks save stocks?

For the past few weeks, equity analysts at JPMorgan have been advising clients that hundreds of billions of dollars in buybacks should only help stocks bottom in the second half of the year.

But the Bank of America team cautioned clients that historically, corporate buybacks haven’t had a huge impact on stock performance.

“Some expect market volatility to be dampened this earnings season by the resumption of buybacks following the end of the company’s blackout periods. But the relationship between S&P 500 buybacks and index performance since 1986 is a minimum of 0.07 R-squared,” the team wrote.


Source: Bank of America

Of course, historical data does not guarantee future performance. But as the team points out in its note, Wall Street has increasingly drawn to the type of “quantitative” analysis presented in the note while becoming less dependent on “fundamental” analysis, which focuses more on a Overall approach supports investing.

As the team points out, the number of open positions on Wall Street for data scientists and other quantitatively-oriented positions is eight times higher than for fundamental analysts. The number of “factor” screens built into Wall Street firms’ models has also increased rapidly, going from an average of less than 10 in 1990 to more than 20 last year. Are retail investors better at picking stocks than hedge funds? Bank of America says the answer is yes.

Brian Lowry

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