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Abstract
This dissertation considers two important issues relevant to the efficiency of institutional investment managers. It examines the trading behaviour of institutional equity funds in relation to investment style drift and dividend payments to assess whether trading is beneficial to investors in these funds. The analysis of investment style is relevant because of the prominence of multiple manager funds in Australia, while institutional investor preferences for dividend income will impact the after-tax return of fund investors.
Firstly, monthly equity fund portfolio holdings are used to examine the magnitude of investment style drift. Institutional investor style tilts are consistent with their self-stated investment objective. Decomposing style drift into active and passive components reveals that institutions retain a desired portfolio tilt by actively adjusting their portfolio holdings in response to passive style drift. Furthermore, funds are most responsive to changes in book-to-market and momentum drift, with style drift affecting portfolio turnover.
Secondly, the dissertation presents an equilibrium framework of dividend valuation and ex-dividend trading under Australia’s imputation tax system. An examination of returns, volume, and order imbalance in the Australian equity market shows that investors value dividends. The results are consistent with long-term investors accelerating trades to the cum-dividend period and short-term traders targeting fully franked, high yielding dividends with a small bid-ask spread. Franking credits possess a positive value for the majority of the sample while transaction costs impede the efficient adjustment of prices on the ex-dividend day. The results show that a 45-day holding period rule reduces the amount of short-term trading from July 1999.
Thirdly, the dissertation places the ex-dividend trading behaviour of institutional equity funds in the context of the findings for the Australian equity market. Institutions accelerate their sales of long-term holdings to the cum-dividend period, and delay purchases until the ex-dividend period to avoid dividends. Institutional trading is consistent with the provision of liquidity to short-term traders that are attempting to capture both dividends and franking credits. The introduction of a long-term capital gains tax discount in 1999 entices institutions to trade in a more tax-efficient manner by selling long-term holdings prior to the ex-dividend day.