Academic journal article Financial Management

Information Diffusion among International Fund Managers: Multicountry Evidence

Academic journal article Financial Management

Information Diffusion among International Fund Managers: Multicountry Evidence

Article excerpt

Investors seeking exposure to global equity markets commonly buy international mutual funds managed by locally based fund managers. How competitive is this form of intermediated investing? We investigate whether international equity fund managers mimic each other's portfolio holdings and analyze the performance implications of these actions. Managers based in the same country have more stocks held in common than those of their peers in other countries. Correlated trading among domestic fund managers contributes significantly to this pattern. Cross-border managers' portfolio holdings and trades are also relevant to the actions of domestic managers. Stock selection strategies based on mimicry and differentiation both deliver short-term superior performance. Mimicked sales occur while prices are rising.

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The globalization of investment flows suggests easier and direct access to markets by foreign investors and less reliance on intermediated asset allocations. However, fund managers investing in international funds and securities on behalf of their domestic clients still attract considerable business. What is the value added by such intermediaries? To what extent do international fund managers differentiate themselves? Our objective in this study is to shed light on peer effects in the portfolio management strategies of international fund managers. We ask whether they mimic each other's portfolio holdings and examine the performance implications of these actions.

The phenomenon of peer effects in stock selection activities has only been explored in domestic settings. A consensus regarding explanations as to why investors' portfolios should be correlated along the proximity dimension is still emerging. Fund managers located in the same region may communicate with their peers informally. Information linkages affecting portfolio decisions are associated with investors' profitable use of shared local information about securities (Coval and Moskowitz, 2001; Hong, Kubik, and Stein, 2005; Feng and Seasholes, 2004; Ivkovic and Weisbenner, 2005) and learning from the trades of others during social interactions in financial markets (Ivkovic and Weisbenner, 2007). Under such conditions, managers exhibit a stronger propensity to imitate the trades of their competitors (Bikhchandani, Hirshleifer, and Welch, 1992). Moreover, fund managers that are close to each other by virtue of being domiciled in the same country are usually subjected to relative or peer-based performance appraisal. Scharfstein and Stein (1990) attribute common investment strategies or the practice they term "reputational herding" to this phenomenon.

Portfolio managers within a country may have access to common sources of research on foreign stock markets. For example, Merton (1987) proposes that, without compromising rationality, investors acquire and hold those securities for which they have the most comprehensive information set. More recently, Veldkamp (2006a, 2006b) presents a model of information sharing in a rational expectations framework. According to Veldkamp (2006a, 2006b), it is the cost of information that drives investors' attraction to the same sources of information. Given that fixed costs are incurred in information production, low-demand information is more costly than high-demand information, leading the average cost-conscious investor to purchase the high-demand, cheaper information on what then becomes a common subset of assets. As a result, it is not the demand for common assets that drives common preferences but rather the demand for information used to price the asset. Regarding the production of the information, Loughran (2008) suggests that the cost of information production for firms is higher for areas with low concentrations of investors (in his case, rural areas) than high concentration regions (urban areas).

In this paper, we adopt the Ivkovic and Weisbenner (2007) definition that attributes information diffusion and correlated trading among investors collectively to "word-of-mouth effects, similarity in preferences, as well as common reaction to news. …

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