By Sanford Bragg
Who profits more from non-public information, U.S. senators or hedge funds? Academic studies suggest that the stock portfolios of U.S. Senators significantly outperform most hedge funds, providing positive abnormal returns of 85 basis points per month over extended periods. Pension funds would do better to invest with senators than with most asset managers.
Two studies—authored by Alan J. Ziobrowski of Georgia State University, James W. Boyd of Lindenwood University, Ping Cheng of Florida Atlantic University and Brigitte J. Ziobrowski of Augusta State University—examined Congressional stock filings to test whether test whether common stocks purchased by Congressmen exhibit positive abnormal returns. The authors hypothesized that if Congressional transactions yield significant positive abnormal returns, it would suggest that Congressmen trade with information unavailable to ordinary investors.
The results showed that the common stocks purchased by Congressmen earn statistically significant positive abnormal returns. A portfolio that imitates the common stock purchases of U.S. Senators outperformed the market by 85 basis points per month on a trade-weighted basis while the Representatives’ portfolio outperforms the market by 55 basis points per month. The authors conclude that the abnormal returns evidence the use of nonpublic information in Congress: “We find strong evidence that Members of the House have some type of nonpublic information which they use for personal gain.”
Congressional portfolios bested returns from corporate insiders, which outperform the market by 50 basis points per month according to studies. According the study, “[Senate] portfolios show some of the highest excess returns ever recorded over a long period of time, significantly outperforming even hedge fund managers.” By contrast, studies of ordinary investors suggest that the average household underperforms the market by 12 basis points per month.
The study authors did not find it surprising that Senators outperformed House members. There are fewer Senators, they hold longer terms and they have the power of the filibuster. Plus, Senators tend to be wealthier than House members.
As we have noted in the past, trading on non-public information is not necessarily illegal for those in Washington. There are no prohibitions against trading information about pending legislation or regulation that impacts stocks.
The Senate Code of Official Conduct places no restrictions on Senators’ securities transactions. In the House, the ethics code prohibits members of Congress from using their official positions for private profit and may not use confidential information obtained in the performance of their government duties for personal gain. However the Ethics Manual for Members, Officers, and Employees of the U.S. House of Representatives defends unrestricted stock trading arguing that divestiture or voting restrictions might impair House members from effectively representing their constituencies.
A study published by Gregory Boller in 1995 showed that members of the United States Congress regularly purchase common stock in companies that they regulate through legislation. From a random selection of 111 Congressional delegates (House and Senate) who purchased common stock from 1991 through 1993, Boller found that 25% of the members sampled “showed stock transactions that directly coincided with legislative activity.”
Do Republicans in Congress outperform Democrats in their stock portfolios? Surprisingly, the studies by Ziobrowski et al., which analyzed transactions made in the 1990’s, found that Democrats outperform Republicans, although only in the House was the difference statistically significant. The authors explain this based on the control of the House at the time. “[I]t should be noted that Democrats controlled the House for 10 of the 17 years covered by this study. Furthermore, Democrats were deeply entrenched in the leadership of the House for decades prior to the study. Thus when Republicans finally took control in 1995, they arguably had far less experience at handling the reins of power and may therefore have been unable to immediately enjoy all its perquisites.”
The study authors call for better transparency in Congressional securities trading, recommending “a policy requiring more timely and complete reporting of congressional security transactions... Reporting requirements similar to those imposed on corporate insiders could be appropriate for helping voters evaluate the behavior of their Representatives in terms of the pursuit of personal profit versus obligations to the public interest.”
The Senate study, originally published in 2004, can be found here. The House study, published earlier this year, can be found here.
Sanford Bragg is president and CEO of Integrity Research Associates, an information and solutions provider specializing in evaluating alternative research.