Do foreign investors under-perform? An empirical decomposition into style and flows

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We study the trading behavior and performance of foreign investors with different management styles. Using a comprehensive Colombian data with complete transaction records and unique investor ID, we find that the aggregate under-performance of foreign investors is largely attributable to the behavior of passively-managed foreign funds, i.e. those that replicate a benchmark index. These funds pay higher prices for stock purchases, receive less when they sell, and display inferior risk-adjusted returns than any other investor type. Contrary to passively-managed domestic funds, net flows to foreign passive funds are pro-cyclical, with inflows (outflows) following positive (negative) market returns. This fact, combined with the strategy to accommodate fund net flows at closing prices by trading multiple stocks at the end of the trading session, imply that managers of passive funds make inferior trades and generate lower returns.

Author(s):

Alvaro Pedraza    
World Bank Group
United States

Fredy Pulga    
Universidad de la Sabana
Colombia

Jose Vasquez    
World Bank
United States