One of the reasons I started Sentiment Matters was that, despite its importance in the investment process, sentiment and positioning analysis typically receive far less attention and research effort than other aspects of investing. I want to help change that.
So, I am always excited when I come across academic research that digs deeper into how investor beliefs are formed, how they influence portfolios and whether they contain useful information about future returns.
This paper by Federico Bastianello and Cameron Peng, Global Fund Managers’ Beliefs, Perceived Mispricing, and Asset Allocation, immediately caught my eye.
Using almost 30 years of data from the Bank of America Global Fund Manager Survey, the authors examine how professional investors assess market mispricing, how those beliefs relate to risk, fundamentals and future returns, and whether they are reflected in actual asset-allocation decisions.
My key takeaways were:
- Institutional investors are more contrarian at heart, and think over a longer horizon, than their reputation sometimes suggests.
- But they do not necessarily invest that way. Actual allocations tend to be more procyclical and driven by short-term fundamentals and risk.
- The research highlights the potential contrarian value of the data captured in our Buy Side Sentiment Tracker.
Let’s go deeper.
The Research
The paper uses almost 30 years of data from the Bank of America Global Fund Manager Survey.
The authors focus particularly on what they call perceived underpricing: the net percentage of fund managers who believe an asset is undervalued rather than overvalued. It is a question that has been asked consistently over much of the survey’s history.
They treat this as a measure of expected returns. The logic is straightforward. When investors believe an asset is trading below its fundamental value, they should also expect it to generate higher returns as that mispricing is eventually corrected.
The survey data on currencies support that interpretation. For the US dollar, euro, yen and sterling, perceptions of undervaluation are strongly positively correlated with expectations that the currency will appreciate over the following 12 months.
The two questions from the paper that I found most interesting are:
- Do those beliefs contain useful information about future returns?
- Are those beliefs reflected in what fund managers actually own?
Institutional investors think contrarian and medium-term
The first important finding is that professional investors’ assessment of value is distinctly contrarian.
That is good to see in the data—and somewhat at odds with the conventional narrative.
Fund managers become more likely to see equities as undervalued after markets have fallen. Their perception of underpricing is negatively related to returns over the previous 12 months and to valuation multiples such as price-to-earnings ratios.