What Determines Mutual Funds' Trading in Foreign Stocks?

Abstract

We examine the portfolio rebalancing, measured by the equity churn rate, of mutual funds from 29 countries based on annual stockholdings over the 1999-2004 period. Our results show that the funds trade more often the stocks of companies located in countries that are less developed, have weaker investor protection, have lower information disclosure standards and are less familiar to the fund managers. The negative relationship between churn rates in foreign securities and quality of information disclosure or degree of familiarity is consistent with the hypothesis that the investors rebalance more often the holdings of stocks about which they know less and are less familiar with. Consistent with the behavioral bias of limited attention, fund managers rebalance more often stocks in foreign markets that performed well. This bias is exacerbated when the fund managers are less familiar and less informed with those markets. Our findings contribute to a better understanding regarding how investors trade foreign shares, and shed some light on the factors that explain cross-border portfolio flows.