Foreign investments during financial crises: Institutional investors’ informational skills create value when familiarity does not

Abstract

During periods of market turmoil, the strategies adopted by institutional investors impact their own financial soundness. Investors’ flight to familiarity during heightened market uncertainty is well documented in the literature. However, the impact of this phenomenon on institutional investors’ performance remains unexplored. In this paper, the performance of US global funds is investigated to assess whether it has been driven by their degree of familiarity with foreign markets or by their selectivity skills during the subprime financial crisis. The paper’s findings suggest that managers’ active stock selection improves fund performance by a significant annualized alpha of 2.24% if this selectivity is based on their informational advantage. In contrast, managers who were seeking familiar stocks to be “on the safe side” during the crisis period did not create value for their clients. These results are valuable for fund managers’ asset allocation strategies during periods of financial turmoil. They are also useful for financial market authorities in their efforts (a) to convince institutional investors towards pursuing their information acquisition activities during crisis periods and (b) to improve investors’ protection in financial markets.