It is now generally accepted that information asymmetry that exists among different
types of investors is one of the key explanatory factors of stock market behavior, especially
if such asymmetry involves huge trading volumes or extreme market volatility. When a
stock market is actively driven by investors who are both well- and mis-informed, it should
be an important issue in financial literature to identify the characteristics of the informed
investors. Taking advantage of the trend of globalization particularly in emerging markets,
foreign investors have played an important role. Grinblatt and Keloharju (2004) and
Kamesaka et al. (2003) report that foreign investors outperform domestic investors significantly
in some stock markets such as in Finland and in Japan. Their results imply
that foreign investors are typically better informed traders than domestic investors in such
markets. In addition, Dvorak (2005) compares the ‘per market transaction profit’ of domestic
investors with that of foreign investors to examine which group of investors was more
informed.
In this paper, however, we attempt to show that a group of investors with high ‘per
market transaction profits’ may achieve lower cumulative returns than the group of investors
who have low ‘per market transaction profits’. Hence the ‘per market transaction profit’
should not be a good measure of informational advantage. Since a necessary condition
to be an informed investor is that he generates profit by trading stocks, the best way
to inspect whether a group of investors is informed is to look into its cumulative return
for a reasonably long period of time. In this respect, we propose using the ‘cumulative
return’ as an alternative measure to ‘per market transaction profit’ in comparing informational advantages of each type of investors.
To show that, we divide all the investors into two groups: foreign investors and domestic
investors. We precisely calculate the cumulative returns of each group employing two sets
of data that run from January 3, 2000 to December 28, 2005. One data set covers the
transactions of the largest 100 stocks listed on the KRX (Korea Exchange) in the tick
data form, and the other contains information regarding the daily level of stock holdings
for each investor group. Covering the 6 year period from 2000 to 2005, <table 4.1> shows
that the cumulative return on stock investment of foreign investors is about 82.6%, while
that of domestic investors is about 21.9%. This gap in performance implies that foreign
investors take up a larger proportion of the informed traders than the domestic investors
do.
In order to identify the determinants of cumulative return, we decompose the cumulative
return into three mutually exclusive components: an asset allocation component, a portfolio
recomposition component, and an intra-day trading component. The asset allocation component
is obtained by subtracting the time weighted rate of return (TWRR) from the cumulative
return. Since TWRR is defined as the return on investment by assuming that interim
cash flows under management are zero, the asset allocation component measures what
additional interim cash flows have taken place because of the asset allocation decisions.
The intra-day trading component measures the share of profit generated by intra-day trading
to the cumulative return. The portfolio recomposition component is determined by subtracting
the intra-day trading component from the TWRR. This measures the share of
profit generated by the inter-day price change to the cumulative return. By probing each
component’s proportion to the cumulative return, we can infer what the major sources
of investor returns are and where their informational advantages come from. <table 4.1>
shows that foreign investors have outperformed domestic investors in each component.
For example, for the 6 year period, the foreign investor asset allocation component, portfolio
recomposition component, and intra-day trading component record 29.3%, 52.5%, and 0.8%,
respectively, while those of domestic investors are -15.5%, 38.0%, and -0.5%, respectively.
Among the three components the largest difference between the two groups of investors
occurs at the asset allocation component, which means that compared to domestic investors
foreign investors enjoy more informational advantages especially in those factors related
with asset allocation strategies.
We applied risk adjusting process to the returns of the portfolio recomposition component
using the market model and the 3 factor model and tested whether there is any significant
difference in the risk adjusted returns between the two groups. <table 4.6> shows that
there is no significant difference in the risk adjusted return between the investor groups
irrespective of the risk adjusting model. This can be interpreted that it is not the informational
advantage in constructing stock portfolio that determines the superior performance
of foreign investors but the informational advantage in their asset allocation strategies.
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