Home Is Where The Profits Are
October 12, 2000
Joshua Coval of the University of Michigan and Tobias Moskowitz of the University of Chicago have found a strong correlation between the geographic proximity of money managers to the companies in which they invest funds and the returns on those investments. Their analysis of fund performance included 1,200 United States funds and 4,600 companies between 1975 and 1994.
Why might this be so?
- Close proximity lowers the cost of acquiring information about a company and constitutes an important informational advantage.
- Consequently, local investors are better informed about nearby firms than distant ones.
- Older funds, funds with more established investments in the community, funds with fewer holdings and funds in remote cities have the greatest propensity to invest locally.
In analyzing the performance of these funds, Coval and Moskowitz found that:
- Local investments earned an additional 2.5 percent annual return or premium over distant investments.
- The local investments the funds avoided generally performed 2.7 percent per year worse than those they did hold.
- Stocks with well-informed, local investors earned 4 to 6 percent more annually.
The authors claim this trend was not found before because most money managers invest minimal assets locally -- but the 20 percent of firms with the most local investments had 10 times the preference for local investing as the 20 percent with the least investments. They also found that the above-average performance of local holdings has declined over the past 20 years. This may be because the Internet and better information technology is eroding the informational advantages of the local investors.
Source: "Geography, Information, and Investment," Economic Intuition, Summer 2000; based on Joshua Coval and Tobias J. Moskowitz, "The Geography of Investment: Informed Trading and Asset Pricing," Center For Research in Security Prices, Working Paper, No. 502, August 1999.
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