Do Local Investors Know More? Evidence from Mutual Fund Location and Investments

Abstract

Although investors' preference for nearby investments has been widely documented in the literature, there is no apparent consensus on whether local investors have any informational advantage. Analyzing the equity holdings of a large sample of actively managed mutual funds, I find evidence consistent with a perception in the mutual fund industry that local funds have an informational advantage. However, the portfolio of mutual funds' local holdings do not display significant superior performance relative to the portfolio of their distant holdings. Using a parsimonious model, I hypothesize that the profitability of local informational advantage will be low due to price impact when there is a relatively large population of local agents who trade on similar private information. Consistent with this hypothesis, I find that funds do earn superior returns on local stocks for which the aggregate local capital is limited and hence the price impact of local trades is likely to be small. Overall, the results suggest that although local investors have some informational advantage, this local advantage does not lead to superior abnormal performance by local managers because of the price impact of their trading.