Hidden Alpha

Using the setting of financial agents – in particular, network ties amongst mutual fund managers and firm officers – we explore the importance of hidden network connections relative to all other network ties. We find that hidden network ties are those associated with the largest and most significant abnormal returns accruing to the fund managers – on average 135 basis points per month (t=3.54) (over 16% alpha per year) across the universe of fund managers and public firms. This is relative to insignificant abnormal returns accruing on average to all of their other trades, including those to trades of “visible” ties in the fund manager-firm officer network. The hidden network premium does not appear to be driven by a familiarity or characteristic selection story, as fund managers seem to be correctly timing exactly when to hold (and when not to hold) the firms to which they have hidden network ties. Further, the more hidden the network tie is, the more valuable the information that appears to be associated with the trading across it. This hidden network connection premium is not driven by any industry, style, time-period, or firm-type, remaining strong and significant through the present day. More broadly, the findings highlight the importance of missing or hidden nodes and connections when understanding the true nature of shock propagation in complex network systems.