A Tale Of Two Styles: Do Qualified Foreign Institutional Investors Have An Edge Over Domestic Funds Managers In China?
School of Economics and Finance, Massey Univeristy, Albany
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Massey University – School of Economics and Finance (Albany)
January 28, 2016
Using a unique quarterly dataset on equity ownership, we investigate Domestic Funds’ and Qualified Foreign Institutional Investors’ (QFIIs) ownership characteristics in the Chinese equity market. Results suggest that both domestic funds and QFIIs tend to hold big firms, firms with relatively higher transaction costs, firms with better accounting performances, firms with higher B/M ratios and higher price to cash flow ratios. Meanwhile, they both hold firms with relative lower P/E ratios, lower betas, and lower price to sales ratios. The performances of both domestic funds and QFIIs holdings are relatively lower than the overall market, when measured by Tobin’s Q. Domestic funds also tend to hold firms with relatively higher turnovers, higher current and quick ratios, and lower firm ages. However, QFIIs tend to hold firms with relatively lower turnovers, lower current and quick ratios, but higher firm ages. We find that domestic and foreign institutional investors have similar preferences towards industry allocations for their holdings. We also observe that foreign institutional investors prefer stocks with higher ownership concentration. Our regression analysis indicates that firms held by domestic funds mangers or QFIIs in the previous period do perform better in the following period. This phenomenon is stronger for domestic funds holdings, suggesting that domestic mangers do have an edge over foreign institutional investors. Our results also demonstrate that the state ownership has been inefficient in terms of firms’ performances, but the ownership concentration and firm’s tangibility do have positive impacts on firms’ performances.
A Tale Of Two Styles: Do Qualified Foreign Institutional Investors Have An Edge Over Domestic Funds Managers In China? – Introduction
On February 10, 2014, PwC released its projection on the global asset under management (AuM): The AuM will rise to roughly $102 trillion by 2020, from $64 trillion in 2012. The majority of these assets are managed by financial institutions, suggesting that the role of institutional investors is crucial to global capital markets. Perceiving this growing importance, researchers have paid increasing attention to studying the issues related to institutional investors especially in emerging economies. China has become one of the focuses of these inquiries. This is not only because it is the largest emerging economy and now the second largest economy in the world, but also because its financial reforms have been successful and its financial markets have attracted more and more international investors over time. One notable contributory factor has been, without doubt, the introduction of the Qualified Foreign Institutional Investors (QFIIs) scheme. This scheme, coupled with the rapid development of the Chinese mutual funds markets, provides an excellent platform to investigate the trading behaviours of domestic and foreign institutional investors in China, which the present study centres on.
One of the motivations of the present study stems from the large amount of media reports and online articles about China’s QFIIs over the past decade or so. Though not consistent throughout, in the most of these years, they reported that QFIIs outperformed their Chinese counterparts – i.e., domestic institutional investors. For instance, in 2014 QFIIs as a whole were reported to expand businesses by 45%, exceeding domestic equity funds’ 32.02%; and in 4th quarter of 2005 alone, QFIIs were said to enjoy a total floating profit of 12 billion RMB over 10 heavily-invested stocks and so to become the champion among all China’s institutional investors in terms of profitability.4 These media-reported success stories should arouse great interest in China’s QFIIs of Chinese and foreign academics, practitioners and regulators. The immediate intriguing questions would be: Have the QFIIs really been more successful than their domestic counterparts in general over a long period of time? If so/not, what have made the former/latter excel in equity investments? Describing aggregate statistics for a particular and short period of time, which media reports and online articles rely on, can only offer a partial and superficial picture, not general conclusions, nor the underlying reasons. This suggests that solid, detailed and in-depth studies are called for. In this paper, therefore, we seek to answer the above two general questions by probing into several specific ones as follows: 1. What are the (possibly time-varying) preferences for stock characteristics in domestic and foreign institutional holdings? 2. What are the industry allocations in domestic and foreign institutional holdings? 3. Are there any differences in corporate governances between domestic and foreign institutional holdings? 4. Does formal econometric evidence exist in ascertaining which group of investors, domestic or foreign, have an edge over the other?
These questions are largely related to the investment styles or the stock-adding/removing skills of institutional investors in China. We choose them to investigate based on the following considerations. Institutional investors, deemed to be more sophisticated than retail investors, have been found to engage heavily in style investing. For instance, according to Froot and Teo (2008), institutional investors reallocate across style groupings more intensively than across random stock groupings. The two authors also find that style investing of different types helps to forecast positively or negatively future stock returns. Thus, style investing, by rotation among different “styles”, is supposed to be important for successful investing. If China’s QFIIs indeed outperform domestic institutional investors overall, the former’s investment styles should be different from (better than) the latter’s, and vice versa. Uncovering the differences amounts to disclosing the trading strategies that can be learnt and further improved by other market participants. Another consideration, albeit not directly relevant to the present study, is that style investing may generate misevaluation or return comovements among individual securities and portfolios (Barberis and Shleifer, 2003; Chang et al., 2013). Our findings of style investing by China’s institutional investors could provide some motivation for further examining the Chinese financial markets on such co-movements, from, e.g., the behavioral finance perspective.
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