Do Foreign Investors Under-Perform? An Empirical Decomposition into Style and Flows

We study 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... [ view full abstract ]

We study 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 attributable to foreign passive funds, i.e. those that replicate a benchmark index. These funds pay higher prices to increase the speed of their trades in order 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. Our findings highlight the potential costs of index investing in developing countries or in securities with low trading activity (small stocks).