These Returns Are for Locals Only!

Ashby Monk

Why am I bullish on the Russia-Direct Investment Fund? And why have I been extolling the potential benefits of SWF collaboration for years? Because the efficient markets hypothesis is flawed, and informational asymmetries that local investors have over non-locals generate additional returns for the locals. In short, when looking in foreign markets, if you can find some savvy locals to co-invest with then chances are you can make some good money. How can I be so sure? Because these three seminal papers say so:

  • Coval and Moskowitz show that fund managers in the US will earn an additional return of 2.65% per year from local investments compared to nonlocal investments.
  • Ivkovic and Weisbenner show that individual investors generate additional returns of 3.2% per year from local investments compared to nonlocal holdings.
  • Malloy shows that geographically proximate financial analysts possess informational advantages over other analysts, which translate into more accurate forecasts.

Basically, these papers are saying that foreign investors and analysts have less information than local investors and analysts and therefore perform poorly relative to their local counterparts. Non-random walkers rejoice!

Significantly, the benefits of local-to-local investing are most pronounced when the target firm is small, young, risky and with high levels of R&D. On the flip side, research also shows that local advantages are diminished when the quality of disclosure increases. So when information is hard to come by, the benefits accrue to the local.

This suggests to me that local advantages will be particularly pronounced in private equity investments (especially those at the growth stage). Indeed, so long as the SWFs do not over-invest in their back yard (i.e., allocate assets for domestic investments beyond the country’s share of global GDP) or fall victim to governance breakdowns, local private equity investments could be very attractive.

Conversely, if you’re a SWF looking to a foreign jurisdictions for PE investments, your first step should probably be to find some smart locals that will co-invest with you (e.g., the RDIF).

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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