Performance of Foreign and Global Mutual Funds: The Role of Security Selection, Region‐Shifting, and Style‐Shifting Abilities

• DOI: http://doi.org/10.1111/fire.12076
• Author: Yangru Wu,Hui‐Ju Tsai
• Date: 01 November 2015
• Published date: 01 November 2015

The Financial Review 50 (2015) 517–545

Performance of Foreign and Global Mutual

Funds: The Role of Security Selection,

Region-Shifting, and Style-Shifting Abilities

Hui-Ju Tsai∗

Washington College

Yangru Wu

Rutgers University

Abstract

We examinethe performance of U.S.-based foreign and global funds after controlling for

their regional and style exposure. We show that, on average, the total performance (TP) and

security selection abilities of both foreign and global funds are significantly negativeand exhibit

short-term predictability.Additionally, R2reflects funds’ security selection abilities, consistent

with previous findings for domestic mutual funds. Investors can earn higher abnormal returns

and TP in the short run by purchasing past winners with low R2than by purchasing past losers

with high R2. However,there is no evidence of predictability in the funds’ region-shifting and

style-shifting abilities.

∗Corresponding author: Department of Business Management, Washington College, 300 Washing-

ton Avenue, Chestertown, MD 21620; Phone: (410) 778-6378; Fax: (410) 778-7891; E-mail: htsai2@

washcoll.edu.

We thank the editor, Bonnie Van Ness, the anonymous referees, and the conference participants at the

2015 annual meeting of the Southwestern Finance Association for helpful comments and suggestions.

Wu thanks the Whitcomb Center for Financial Services at the Rutgers Business School for data and

financial support. Part of this work was completed while Wuvisited the Central University of Finance and

Economics. We are responsible for anyremaining errors.

C2015 The Eastern Finance Association 517

518 H.-J. Tsai and Y.Wu/The Financial Review 50 (2015) 517–545

Keywords: global and foreign funds, performance persistence, region-shifting abilities, style-

shifting abilities, security selection abilities

JEL Classifications: G11, G15, G20

1. Introduction

The importance of U.S.-based foreign and global funds can be seen from their

increasing popularity among investors over the past decade.1From 2000 to 2012,

U.S.-based world equity fund assets grew from $553 billion to $1614 billion, with

an average annual growth rate of over 9%. In 2012, U.S.-based world equity funds

accounted for about 12% of total U.S. mutual fund assets (ICI, 2013). The popularity

of foreign and global funds can be attributed to the diversificationbenefits they provide

to investors (Grubel, 1968; Levy and Sarnat, 1970; Eun, Kolodny and Resnick, 1991;

Detzler and Wiggins, 1997). Additionally, some investors believe that international

equity markets are less efficientand thus allow skilled fund managers to earn abnormal

returns (Tkac, 2001).

While there are considerable studies on the performance of domestic mutual

funds (e.g., Grinblatt and Titman, 1992; Carhart, 1997; Daniel, Grinblatt, Titman and

Wermers, 1997; Wermers, 2000; Brands, Brown and Gallagher, 2005; Kacperczyk

and Seru, 2007; Cremers and Petajisto, 2009; Amihud and Goyenko, 2013), research

on the performance of foreign and global funds is not as extensive (Cumby and Glen,

1990; Gallo and Swanson, 1996; Glassman and Riddick, 2006; Jiang, Yao and Yu,

2007; Turtle and Zhang, 2012). Furthermore, current evidenceabout the performance

of foreign and global equity funds is mixed. For instance, Cumby and Glen (1990) use

Jensen’s alpha and positive period weighting measure to compare the performance

of 15 U.S.-based internationally diversified mutual funds to a broad market index

and do not find evidence of positive abnormal returns. Similarly, Breloer, Scholz and

Wilkens (2014) and Comer and Rodriguez (2012) find negative average abnormal

returns earned by foreign and global funds. By contrast, Detzler and Wiggins (1997)

find that international mutual funds outperform the inefficient world index.Gallo and

Swanson (1996) show superior performance of international mutual funds. Fan and

Addams (2012) and Fortin and Michelson (2005) also find some evidence of superior

performance of U.S.-based foreign funds.

Current studies on foreign and global fund performance typically use the single

global equity index as a benchmark. However, Comer and Rodriguez (2012) show

that foreign and global funds have a wide variety of risk exposure across regional

markets and more importantly, their risk exposure can be quite different from that of

1U.S.-based foreign funds are different from global funds in that the latter have much higher exposure to

the U.S. market.