Do Foreign Investors Underperform? An Empirical Decomposition into Style and Flows
45 Pages Posted: 11 Apr 2017 Last revised: 27 Apr 2018
Date Written: March 13, 2017
This paper studies the trading behavior and performance of foreign investors with different management styles. The analysis uses a comprehensive Colombian data with complete transaction records and unique investor identification, and finds that the aggregate under-performance of foreign investors is attributable to foreign passive funds, that is, those that replicate a benchmark index. These funds pay higher prices to increase the speed of their trades to accommodate daily flows proportionally to their index before market closing. Passive funds face higher transaction costs on days when they trade multiple stocks in the same direction, buy (sell) the same stock multiple times, and make large trades near the daily closing time. Meanwhile, foreign active funds trade at more favorable prices and display higher risk-adjusted returns than any other investor group, including domestic funds with similar active management. The findings highlight the potential costs of index investing in developing countries or in securities with low trading activity (small stocks).
Keywords: International Trade and Trade Rules, Non Bank Financial Institutions, Capital Flows, Capital Markets and Capital Flows, Mutual Funds, Social Funds and Pensions, Private Sector Economics, Marketing, Private Sector Development Law
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