Is Congress Using Inside Information To Beat the Street?

Fund managers continually wrack their brains trying to figure out how to generate alpha. Perhaps they could look to Congress for tips on how to consistently beat the market.

According to a study published in the academic journal Business and Politics, a portfolio mimicking the stock purchases of U.S. House members beat the stock market by 55 basis points a month and 6 percent a year. The research suggests those returns are no accident, with congressmen using their access to non-public information to gain an edge on when to buy stocks.

The study's authors - Alan Ziobrowski of Georgia State University, James Boyd of Lindenwood University, Ping Cheng of Florida Atlantic University and Brigitte Ziobrowski of Augusta State University - analyzed the returns of more than 16,000 stock trades made by nearly 300 House delegates between 1985 and 2001.

"We find strong evidence that members of the House have some type of non-public information which they use for personal gain," the researchers wrote. "The nature and source of information is unknown, but clearly further research is warranted."

The study found, however, that while the congressmen used an informational edge to buy common stocks at the most opportune times, they usually dumped the investments before they peaked, suggesting they lacked an insider's edge on when to sell. "We basically tracked and compared their returns to those of the market to determine whether their profits were superior in statistically significant fashion to those of the average guy," Ziobrowski tells Advanced Trading.

"We also recognize that members of Congress have information that may be very pertinent to the performance of common stock that nobody else has."

A Fine Line Between Illegal and Unethical

The practice differs from criminal insider trading since the lawmakers aren't corporate insiders making trades on potentially market-moving information from within a public company. Nevertheless, the idea of congressmen profiting from dealings on information that's unavailable to the voting public is disturbing.

The issue was thrust into the spotlight last fall following a Wall Street Journal investigation, which found that congressional aides also reaped the benefits of such transactions. The newspaper reported that 72 aides from both major political parties traded stocks within industries legislated by their superiors. The ensuing fallout brought renewed life to the Stock Act, a bill that's languished in Congress since 2006, which would ban legislators and their staffers from making investments based on information unavailable to the public.

The proposed bill also would require legislators and their employees to disclose any stock, bond or commodity futures transaction worth more than $1,000 within 90 days. Under the current guidelines, such deals don't have to be reported until six months or more after they've been made.

"What I do find disturbing is the potential for me pushing legislation that would benefit my portfolio. That's unethical," says Georgia State's Ziobrowski.

"On the other hand, if I find out XYZ Company's tax status is about to change because they're going to become a kind of preferred industry and I trade on that knowledge, I don't have a problem with that because you're not affecting the markets."

Senate Supremacy

The practice of lawmakers trading on non-public information apparently has not been limited to members of the House. The researchers published a study in 2004 showing that stock purchases by U.S. senators outperformed the wagers made by their House counterparts.

In an analysis of investments made by senators between 1993 and 1998, the researchers discovered that they beat the market by 85 basis points a month, or 10 percent a year. That report also suggested that senators had better information on when to cash in their shares than their House colleagues, since their stocks often declined in value soon after a sale.

"We hypothesize that power is more diluted in the House of Representatives, which is likely to reduce the informational advantages of House members and result in lower excess returns," the researchers wrote concerning the disparity between House and Senate investment returns.

Meanwhile, the House study found that democrats earned more than republicans between 1985 and 2001. During that 16-year period, democrats beat the market by 73 basis points a month, or 9 percent a year, compared to 18 basis points a month, or 2 percent a year, for GOP members.

"In the late 1980s the democrats had held the House for many decades," Ziobrowski points out. "A lot of them were deeply entrenched in their positions, and they may have been able to tweak the government in a more serious fashion." As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio