Domestic and Foreign Institutional Investor Behavior in China

Abstract

This paper compares different preferences between foreign funds operating under Qualified Foreign Institutional Investor (QFII) in China and domestic Chinese funds and analyzes the firm-level drivers that influence their allocation choices. The analysis reveals that foreign funds have a preference for a range of sectors such as transportation, metals & non-metals, and machinery, as opposed to industries with a requirement for local knowledge. The portfolios of domestic Chinese funds are distributed more evenly across sectors, compared to foreign funds. The comparative analysis reveals that the companies foreign funds invest in are significantly different from those firms favored by domestic funds in terms of size, profit and compensation of management. Finally, we find that when making investment decisions, domestic funds tend to emphasize on some basic financial indicators, e.g. size and long-term liabilities paying capability rather than corporate governance structure of a firm. In contrast, however, QFIIs emphasize on financial characteristics, e.g. free cash flow as well as corporate governance structure, e.g. compensation of management. These empirical findings highlight the differences between QFIIs’ and domestic funds investment preferences, and have implications for policy makers aiming to attract foreign investors to invest in emerging markets.