Retail investing has undergone a seismic shift in recent years, with individual investors now accounting for a growing share of market activity. R. David McLean, Jeffrey Pontiff, and Christopher Reilly, authors of the study “Taking Sides on Return Predictability,” published in the November 2025 issue of The Journal of Financial Economics, examined how different types of investors actually perform. Their findings provide insights into who makes smart trades and who doesn’t.
What the Researchers Examined
This study represents the most comprehensive analysis of market participation to date. The authors examined the trading patterns of nine different types of market participants:
- Six types of institutional investors: mutual funds, banks, insurance companies, wealth managers, hedge funds, and other institutions
- Short sellers: primarily hedge funds betting against stocks
- Firms themselves: through share buybacks and issuances
- Retail investors: individual investors
The researchers analyzed these groups’ trading patterns across 130 different stock return anomalies—characteristics that academic research has shown predict future stock performance. They calculated changes in ownership over the one- and three-year periods preceding the month that the anomaly variables were constructed. This measurement informed how each market participant changed their ownership in the years leading up to portfolio formation. Their data sample covered the period from October 2006 through December 2017.
The Key Findings: Winners and Losers
The Smart Money: Firms and Short Sellers
Firms emerged as the most informed traders. When companies issue or buy back their own shares, they tend to get it right. Companies with the lowest expected returns issued the most shares, while those with higher expected returns were more likely to buy back stock. The 130 predictive variables explained 32% of the variation in share issuance over three years. Even after accounting for all publicly available information reflected in the anomaly variables, firm trading still predicted returns. Corporate insiders know something the rest of us don’t.
Short sellers were the second-most informed group. They systematically targeted stocks with low expected returns, and their trades predicted lower future returns. However, once the researchers controlled for the 130 anomaly variables, short sellers’ predictive power largely disappeared. That finding led the authors to conclude that, unlike firms, short sellers don’t appear to have much private information—their success comes from effectively using publicly available data.
The Struggling Money: Retail Investors
The news for individual investors is bad. Retail investors made the worst trading decisions across the board:
- They bought stocks with low expected returns and sold stocks with high expected returns.
- Their accumulated trades over one and three years predicted returns opposite to their intended direction.
- The 130 anomaly variables explained 18% of their three-year trading patterns.
However, there’s a curious paradox: While retail investors’ long-term accumulated trades predicted poor returns, their short-term trading surges (measured weekly) actually predicted positive returns. This finding is consistent with prior research. This led the authors to conclude: “These results show that temporary spikes in retail trading (that is, weekly trade imbalances) predict returns in the intended direction, whereas retail trading aggregated over long horizons (our variable) predicts returns in the unintended direction.”
The Neutral Money: Institutional Investors
Perhaps most surprisingly, none of the six institutional investor types showed robust return-prediction ability:
- All institutional groups held more stocks with low expected returns than high expected returns—institutions contribute to anomalies!
- The anomaly variables explained only 5% or less of institutional trading over three years.
- Institutional trading appears largely random with respect to future returns.
The findings on hedge funds were particularly striking. While hedge funds excel at short selling (which is highly informed), their long equity positions were poorly positioned relative to anomalies, failing to predict positive returns.
Takeaways for Investors
1. Be Humble About Your Stock-Picking Ability
If professional institutional investors with vast resources can’t consistently pick winning stocks, individual investors should be realistic about their chances. The data demonstrates that retail trading decisions tend to underperform.
2. Consider Following Corporate Insiders
Pay attention to corporate buyback and issuance activity. When companies aggressively buy back shares, it’s often a positive signal. Conversely, heavy share issuance may indicate management believes the stock is overvalued.
3. Short Interest Contains Information
High short interest isn’t just market noise—it reflects informed analysis (even if it’s based on publicly available information). Stocks with increasing short interest tend to underperform.
4. Don’t Overtrade
The finding that retail investors’ short-term trade surges predict positive returns, while their longer-term accumulated positions predict negative returns, suggests that frequent trading and constant repositioning may be harmful to performance.
5. Institutions Aren’t Magic
Don’t assume that just because mutual funds or other institutions are buying a stock, it must be a good investment. The data shows institutional positioning relative to predictable return patterns is poor.
6. Consider Passive Strategies
Given that even sophisticated institutional investors struggle to position themselves advantageously, passive index/systematic quant investing becomes even more attractive.
The Bottom Line
This research paints a sobering picture for active investors. The most informed participants—firms trading their own stock and short sellers—have clear informational or analytical advantages. Meanwhile, retail investors and institutions alike struggle to position themselves on the right side of predictable return patterns.
For most individual investors, the message is clear: Humility and systematic, passive strategies beat overconfidence and active trading. Unless you have genuine informational advantages (which you almost certainly don’t possess), a low-cost, diversified, buy-and-hold approach remains your best bet for long-term wealth building.
The author or authors do not own shares in any securities mentioned in this article. Find out about
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