According to finance theory, a stock's price at any moment in time represents the present value of future expected cash flows. Prices fluctuate because investors disagree on what those cash flows will be or at what rate they should be discounted. When new information hits the market, stock prices can exhibit tremendous volatility.
As most investors know, it is extremely difficult to earn excess returns by relying solely on publicly available information, yet it is very easy to make a lot of money by relying on material and non-public information; what is often referred to as inside information. The problem, of course, is that using inside information is illegal. As a result, some investors looking for an edge try to access material information that is not necessarily coming from "inside" the corporation. Today's New York Times provides an excellent example of hedge funds operating in this gray area.
In Surveys Give Big Investors Early View From Analysts, Gretchen Morgenson explains how some of the biggest hedge funds are getting an early peek at what analysts think about the companies they cover. Morgenson claims that certain documents actually "state that the goal is to receive nonpublic information." What's worse, she says that documents state that surveys filled out by analysts for hedge fund clients "allow for front-running analyst recommendations."
While it is not clear if this practice of surveying analysts constitutes a violation of law, it certainly adds to the suspicion and unease that many ordinary investors share that the stock market is not operating on a level playing field. Hedge funds, in particular, are using more and more sophisticated technologies that allow them to buy or sell large amounts of stock in milliseconds, before other investors can access or process information. This explains in part why so many retail investors are either out of the market entirely or investing solely through mutual funds or exchange-traded funds. Morgenson's article will no doubt prompt regulators to ask a whole lot of questions.
