Where Is Your Fund Manager From?
Which emerging-markets mutual fund is likely to do better: one run by a Bruegger, or one run by a Barbosa?
There's been a lot of research into how investors tend to favor their country of origin in their portfolios -- a so-called home bias. It's usually spoken of disparagingly, as a symbol of investors’ myopia regarding all the opportunities outside their home country. Rarely examined are the potential advantages such a bias can confer.
A recent academic paper, “The Home(-sickness) Bias of Foreign Holdings,” braves these murky waters and finds that, among U.S.-based fund managers, a Brazilian-born manager who speaks fluent Portuguese and is familiar with the country's business culture had better results when investing in Brazilian companies than a German-born manager.
Duh? It gets more interesting.
Investors With Know-How
Famed Fidelity manager Peter Lynch always said “invest in what you know.” Research by University of Illinois at Urbana-Champaign Ph.D. candidate Quoc Nguyen backs that up, revealing an “information asymmetry” that can give cultural insiders an edge in managing U.S. stock funds that have an international stock component. Nguyen's study found that from the start of 1999 to the end of 2010, U.S. “funds that overweigh stocks from the local ethnic group's home country outperform otherwise similar mutual funds by 1.4% per quarter in their international holdings.”
It wasn't just the manager's ethnicity that mattered, it turned out, but the ethnic makeup of the community where the funds’ main offices were located. Nguyen used data from the U.S. Census Bureau’s annual American Community Survey to determine the ethnic composition of communities throughout the U.S. He then employed a computer algorithm that analyzed fund managers’ names to determine ethnicity. (Ambiguous last names like “Lee” can cause problems, though taking the first name into account can help reduce ambiguities.)
Nguyen found that funds which held main offices in communities that had a high concentration of a specific ethnicity held 14 percent more in stocks from that ethnicity’s home country than peers. By contrast, when there was no such concentrated community, the funds invested 9 percent more in the manager's ethnic homeland than otherwise similar funds.
Part of the reason community matters is that if a money manager’s clients, friends and family are of a particular ethnicity, they may have insights into the business culture of that ethnicity and provide new investment ideas. On the other hand, clients, friends and family may exert pressure on the manager to invest in their home country in a way that leads to decisions driven more by emotions than by an information edge.
In Nguyen's research, outperformance was stronger among managers whose families hail from emerging-markets nations. Part of the reason may simply be that Americans from Western European backgrounds are likelier to have been in the U.S. for at least several generations and have fewer ties to their original cultures. Nguyen cites other causes: “There is a higher information asymmetry between U.S. investors and China compared to U.S. investors and the U.K.,” he says. “In the U.K., financial reports are clearer, the language is easier to follow, and accounting standards are better than in China or India.”
Strangely enough, the ethnicity effect is strongest in funds that invest primarily in the U.S. but dabble in foreign stocks, as opposed to funds that invest exclusively overseas. (Nguyen studied U.S. funds with similar foreign exposure to make an apples-to-apples comparison.) "If your fund's objective is international, you should put all of your resources, money and time to reduce that information asymmetry as much as possible," Nguyen says.
For example, the main office of Grandeur Peak International Opportunities Fund is located in Salt Lake City -- not exactly a melting pot of ethnic diversity. Yet the fund has managed to beat 92 percent of its peers in the past year because co-manager Blake Walker devotes significant resources to overcoming any informational disadvantages. "Our team in the past year has been to 30 different countries," he says. Walker, a Canadian, has a diverse investment team that speaks seven languages.
A Skeptic’s Take
Not everyone buys the idea that the ethnicity of a manager or of a local community affords an information edge. Alec Walsh, co-manager of the top-performing Harding Loevner Equity Fund, thinks home bias can blind money managers to investment opportunities outside their comfort zone. “I don’t doubt people favor what they know best by geography and sector,” he says. “I think that knowledge actually leads to overconfidence about your abilities to forecast the future.”
Walsh also notes that world markets have become increasingly homogenous in the last 20 years thanks to the Internet and globalization. So the information asymmetry is not as great as it once was. That said, he adds that in certain countries, having a native on staff is an advantage. He has one Japanese-born analyst, Yoko Sakai, who spends four months a year in Japan.
“We normally have global sector analysts who cover an entire sector throughout the world,” Walsh says. “But we invested in Japan for 15 years unsuccessfully using that model. We finally threw in the towel and hired a Japanese specialist who works in conjunction with our sector analyst. She's been able to find companies which meet our criteria that we wouldn't have been able to find.”
(Lewis Braham is a freelance writer based in Pittsburgh.)
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