EDINBURGH - Who invests better in a given stock market, the home team or a foreign competitor?
While the virtues of a centralized investment team vs. those of local experts have been debated for years among money managers, relatively little research has been done when domestic pension funds are competing head-to-head with foreign counterparts.
According to a report by The WM Co., the answer lies heavily in favor of the domestic investor. The Edinburgh-based performance measurement firm found U.S., British and Dutch pension funds consistently outperform their international rivals in their home markets.
Part of the explanation may be that domestic funds typically are more diversified in their home markets than the competitors, said Gordon Bagot, WM's director of research and consultancy.
Foreign-based funds typically invest a minority of assets in non-domestic equities, and a smaller amount in any given market. Often, they are more heavily weighted in larger-capitalization stocks, and thus may lose higher returns from smaller-cap stocks. While an individual foreign pension fund might outperform the domestic average, collectively they fail to, Mr. Bagot said.
Another factor is that managers with international or global mandates are less focused on individual market segments and more concerned with investments and performance of the entire portfolio, said Meredith Brooks, director-investment services, Frank Russell International, London.
Still, an analysis of WM's data finds results are not uniform. In its fifth annual report on the subject, titled "Home and Away," WM Co. officials used three-year rolling averages plotted relative to local market averages.
The U.K. market provides one of the clearest contrasts. The data from three-year periods from the end of 1986 through the end of 1993 reveals returns of U.K. pension funds have closely followed the Financial Times-Stock Exchange All-Share index. After adjusting for the bid-offer spread and the costs of investing new cashflow, the returns are nearly the same, the report said.
In comparison, U.S. pension funds substantially underperformed the index over time. Their results would place them in the bottom quartile during the entire period, and in the 83rd percentile in the three-year period ended December 1993, WM found.
U.S. funds are less diversified than their British counterparts and tend to concentrate holdings in larger-cap U.K. stocks, which fared poorly in 1993, the report noted. Sufficient data from Dutch fund investments in British stocks were not available.
Similarly, Dutch pension funds consistently have been the best investors in Dutch stocks, hewing close to the average return. In contrast, U.K. pension funds greatly underperformed the FT-A World Index for Holland for the three-year periods ending in 1986 and 1987, by up to 11 percentage points. Returns were around three percentage points a year below the index in the next few years and have tracked the index closely since 1992.
U.S. funds have underperformed the Dutch index since the end of 1988. From the third quarter of 1990, U.S. pension funds have underperformed both U.K. and Dutch funds in every period.
But U.S. pension funds outperformed the British and Dutch funds in the U.S. market. Returns for U.S. funds have been closest to the Standard & Poor's 500 Index for the 10 years, outperforming in eight of the 24 three-year periods - including the last five.
Interestingly, Dutch funds have outperformed their British peers in every period for which data is available.
A further comparison is found in the Japanese stock market, where no fund enjoyed a home-team advantage. All three groups underperformed the Tokyo New Stock Exchange Index for periods up to the fourth quarter of 1989.
For the next two periods, both U.K. and U.S. funds closely tracked the index. Thereafter, both outperformed the index, with the exception of two periods. But in all periods except one, British funds beat U.S. funds.
Dutch funds, in comparison, continued to lag the index through 1990, four periods more than their American and British peers. They continued to trail their foreign peers in more recent periods, although lately they have produced better returns than their U.S. counterparts.