Foreignness and the Incentive to Generate Alpha: Evidence from Offshore Cross-Border Mutual Funds

Abstract

We analyze European mutual funds that are domiciled offshore (in Luxembourg or Ireland) and sold across the world. These offshore cross-border funds are more actively managed and have a markedly stronger flow-performance sensitivity. This implies a more sophisticated clientele—i.e., more performance-sensitive, less concerned with brand foreignness—and a greater incentive to generate alpha. Consistent with a skill-based argument, such funds consistently outperform relative to their onshore counterparts. Importantly, the return predictability of active management is more than twice as high for offshore cross-border funds. Finally, we rule out an alternative explanation based on a more diversified shareholder base.

Keywords: Mutual Funds, Offshore, Familiarity, Trust, Performance, Active Fund Management, Information Advantage, Flow-Performance Sensitivity

JEL Classification: G11, G12, G14, G15, G23