The Performance of International Equity Portfolios

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The Performance of International Equity Portfolios

• Frank Warnock
• Darden Business School (University of Virginia)
• and
• Federal Reserve Board

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Investors are venturing abroad to a greater
extent...
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but are still underweight foreign equities
relative to global benchmarks.
Share in World Markets
Share in US Portfolios
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Main Question Do investors perform poorly when
they venture abroad?

• Theory says yes.
• Foreign investors may be at an information
  disadvantage.
• Empirical work says probably, but is limited.
• Some work from the 1980s on US mutual funds.
  More recent work on UK fund managers performance
  in the US and three other markets.

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What We Do

• Form data on the monthly positions of US
  investors in 40 non-US markets.
• Within each country, we assume they hold the
  market, so our paper is about country picking,
  not stock picking.
• Find that US investors, as a whole, were able to
  beat the MSCI benchmark, especially since 1990,
  in both developed and emerging markets.
• Higher Sharpe ratios through higher returns and
  lower volatility.
• We examine unhedged returns, so could owe to the
  ability to forecast exchange rates(but not
  likely).
• Explore potential reasons for the strong
  performance.

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Monthly International Portfolios, Dec 1976 Dec
2001

• Infrequent comprehensive surveys of cross-border
  holdings act as fixed points.
• To interpolate positions between survey dates,
  utilize monthly capital flows data and MSCI/IFC
  price returns.
• Errors in capital flows data force us to restate
  the flows.
• Result Benchmark-consistent positions and
  flows between the US and 40 countries.

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Mean (Standard Deviation) of Monthly Excess
Returns (in , 1990-2001)
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Reasons for the Strong Performance
Reason 1 Avoided Returns-Chasing Behavior

• In the theoretical model of Brennan and Cao (JF
  1997), informational disadvantages lead to
  returns-chasing behavior, which Choe, Kho, and
  Stulz (NBER 2004) argue leads to poor
  performance.
• In contrast, we find no evidence of momentum
  trading, but rather a tendency to sell past
  winners.

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Reasons for the Strong Performance
Reason 2 Exploited Past Price Information

• More specifically, we do not find that they had
  superior conditional performance.
• Yes, they beat the MSCI benchmark.
• But, using conditional returns-based and
  conditional weight-based models, we find no
  evidence that they moved into markets just prior
  to positive abnormal returns (or out of markets
  before negative abnormal returns).

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Reasons for the Strong Performance
Reason 3 Tilted Portfolios Toward Countries with
Strong Governance and More Cross-Listed Stocks

• Yes, they beat the MSCI, but US investors
  foreign portfolios
• Performed significantly worse than a cross-listed
  portfolio (formed by applying cross-listing
  weights to MSCI returns), and
• Performed worse than a governance portfolio
  (formed by applying governance weights to MSCI
  returns).

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Mean (Standard Deviation) of Monthly Excess
Returns (in , 1990-2001)
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Underweighted Japan and Emerging Asia
Overweighted LatAm and Scandinavia
Data are average annual averages from 1990-2001.
Excludes countries for which the overweight is
less than 0.3 in absolute value.
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Conclusion

• Using monthly bilateral holdings measures between
  the US and 40 countries
• We show that US investors foreign portfolios
  beat the MSCI benchmark.
• The superior performance appears to owe to
  avoiding returns-chasing behavior, skillfully
  exploiting past information, and weighting
  portfolios towards countries with good governance
  and more cross-listed stocks.

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Further Information/Disclaimer

• This presentation is based on joint work with
  Charlie Thomas and Jon Wongswan of the Federal
  Reserve Board (International Finance Discussion
  Paper 817, August 2004).
• Due to data limitations, the talk is decidedly
  US-centric and is about country picking, not
  stock picking.
• Disclaimer The views are solely the
  responsibility of the authors and should not be
  interpreted as reflecting the views of the Board
  of Governors of the Federal Reserve System or of
  any other person associated with the Federal
  Reserve System.