Social Networks and Stock Returns
February 24, 2009
But the networking effect was not limited to top schools. Malloy stressed that his findings do not show an “elitist” effect. Even when he eliminated the top 30 institutions from his data, social networking still led to superior performance.
Nor is this a school-specific phenomenon. Investing solely in fund managers who went to prestigious colleges does not result in outperformance, nor would selecting only companies with – for example – Harvard-educated management teams.
“The key is that fund managers and sell-side analysts pick the right stocks” based on their personal social networks, Malloy said. “It is all about information flow.”
Although he studied only educational connections, Malloy said his research could be extended to other types of social networking – country club memberships, military backgrounds, or religion, to name a few. “The stronger the tie – where strength is defined by the likelihood of interaction and information flow – the bigger the results,” he said.
Information on when to buy securities was more valuable than information on when to sell – that is, the outperformance of purchased securities exceeded the underperformance of those that were sold. That may indicate that management is more willing to share good news than bad, Malloy said.
Implications for advisors
Malloy’s research does not offer any guidance for mutual fund selection, primarily because the overall level of outperformance attributable to connectedness is small (only two basis points). It also does not indicate whether better-educated or better-connected fund managers deliver superior performance or, more broadly, whether skillful fund managers possess any characteristics that allow them to be identified beforehand.
But Malloy’s work suggests one very useful strategy for stock selection. Most funds hold between 30 and 50 stocks. Typically, about five of those stocks will have an educational social network connection of the type studied by Malloy and his co-authors. “If you just buy only those connected stocks, you will achieve considerable outperformance,” Malloy said.
Executing this strategy requires a lot of data. You would need to go to a vendor like BoardEx or ZoomInfo to obtain data on the educational background of corporate management teams and to Morningstar for fund manager resumes. No commercial solutions exist for combining this data – which may account for the superior level of outperformance – so implementing the strategy would require a substantial IT investment.
But Malloy is confident in the validity of his results. “The evidence does not suggest there is long-term fund manager outperformance persistence,” Malloy said. “But our results, over a 16 year period, show a strong source of persistent advantage.”
Will this advantage continue into the future? Malloy says yes – “Networks are a lasting source of competitive advantage,” he said.
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