Ownership Composition, Liquidity, and Liquidity Risk

This paper describes the ownership composition of U.S. stocks by institutional investors and more specifically by mutual funds and hedge funds. We document that there is a large cross-sectional and time-series variation of ownership across different mutual fund styles and hedge fund investment strategies. The flows of funds towards different styles and strategies is very heterogeneous and largely uncorrelated. There is also a very heterogeneous preference of different mutual fund and hedge funds for stock liquidity. Armed with this evidence, we find that institutional ownership generally predicts larger stock liquidity, and so does concentrated ownership with mutual funds and, to a lesser extent, hedge funds. However, when we examine the effects on liquidity risk, we obtain the opposite evidence. Stocks with concentrated institutional ownership and especially hedge fund ownership tend to have low returns when market illiquidity is high, suggesting that the correlated trading strategies have a detrimental impact on returns when markets are less liquid. Interestingly, the effect on liquidity dynamics seems to depend on investment styles.