The Power of Alumni Networks

Information moves the market—that’s understood. But how information moves through the market to eventually affect stock prices is less well understood. After analyzing more than 15 years’ worth of investment data, we’ve found one way that information gets around and improves investing performance: through alumni networks.

We examined a vast data set of trading decisions of mutual fund portfolio managers from 1990 to 2006. We compared the performance of managers’ investments in “connected firms”—that is, companies where at least one senior official had gone to the same college as the investor—with performance investing in “nonconnected” firms—where no college ties existed between the senior ranks and the investor.

Our results reveal a strong pattern, in both stock holdings and returns: U.S. mutual fund portfolio managers placed larger concentrated bets on companies to which they were connected through an education network. And the fund managers performed significantly better on those connected positions than they did on nonconnected ones, to the tune of 7.8% a year.

Fund managers placed more and larger bets on companies where a senior executive went to the same college as the investor. The more closely they were connected, the better the returns.

What’s more, both the size of their bets and the size of the returns increase with the strength of the connection. For instance, if the mutual fund manager and the CEO of the company were both Wharton MBA graduates, Class of 1970, the effect would be even stronger than if the manager graduated in 1970 and the executive in 1980.

Investors weren’t just betting against companies to which they had no college ties; they were accurately identifying the companies within their alumni network that were the better investment targets. Connected stocks that managers chose to hold outperformed connected stocks they chose not to hold, by 6.8% a year. The same effect played out when we examined the activity of sell-side analysts.

Cynics will consider these results evidence of, at best, an old-boy network or, at worst, insider trading. Indeed, for stock analysts in the United States, the alumni network effect dampens significantly right around 2001, after the SEC’s Regulation FD (Fair Disclosure) went into effect and mandated ubiquitous rather than selective communication between CEOs and analysts. (There was no such regulation in the UK, and the effect did not dampen there.)

However, the power of social networks—human ones, not online platforms—to disseminate valuable information is another explanation. Alumni networks turn out to be an especially effective kind of social network. This is in part because people often self-select into undergraduate and graduate programs that have social groups with interests closely aligned to their own, which generates both a higher level of interaction and longer-lived relationships.

The depth and persistence of college networks means that fund managers and analysts amass—incidentally and on purpose—detailed information about fellow graduates. They’re more likely to have met each other or have common acquaintances. They understand what it means if a person belonged to a certain club or participated in a specific study program. They may know people who hired them previously. And so on. All this helps them better assess executives’ potential as leaders and business owners.

A version of this article appeared in the October 2010 issue of Harvard Business Review.