Do institutional investors perform better in emerging markets?

Abstract

Emerging markets with their imperfections, low liquidity, and dominance of naive retail investors are likely to provide attractive profit-making opportunities for sophisticated and resourceful institutional investors. The institutional investors traditionally had low participation in these markets, but it has grown tremendously during recent years. Therefore, these markets provide a natural experimental setting to understand the implications of their activities on asset pricing and to evaluate their market timing and stock-picking skills. In this study, we compare the performance of foreign institutional investors (FIIs) and domestic institutional investors (DIIs) in one of the important Asian emerging markets. We observe that the institutional investors (FIIs and DIIs) prefer to invest in low-risk (low beta, low book-to-market ratio, and high market capitalization) stocks. The portfolios of the stocks with higher FII holdings have lower returns than those with lower FII holdings, particularly after risk adjustments. Similarly, the portfolio of the stocks bought in a quarter by FIIs offers inferior returns in the next quarter compared to the portfolio of the stocks sold by them. Institutional investors are momentum traders. Their trading activities are negatively autocorrelated, indicating short-termism and cyclicality in their trading behavior. We do not observe any superior market-timing and security picking skills among them.