Investors Trade Foreign Equities More Often Than Their Domestic Counterparts

There has been significant research in the past looking at the phenomenon of "home bias," or investing a larger portion of your wealth in a domestic market, despite the benefits of increasing international diversification. Less research has been done on how these home bias investors rebalance between domestic and foreign exposure. Previous research has also produced somewhat conflicting data regarding foreign equity turnover rates, ranking them from having only slightly faster levels of turnover, to foreign equity turnover rates 10 times greater domestic equity turnover rates - although in many cases the data samples were limited to just a handful of countries.

Recent research by Kalok Chan and Vicentiu Covrig examined portfolio rebalancing as measured by the churn rate of mutual funds from 29 different domestic countries - with investments across 48 foreign countries (see their paper, "What Determines Mutual Funds' Trading in Foreign Stocks?"). The results were based on annual holdings of stocks from the years 1999-2004, with churn rates based on changes of equity holdings in consecutive years. Based on past research, it was not surprising that their results found that the level of stock trading is more active for the stocks of companies in less developed countries. In fact, the trading of mutual funds in foreign stocks was higher than for domestic stocks in 24 out of 29 countries. When digging deeper to determine the reasons for the increased turnover rates, the authors found that the level of trading is higher for stocks in markets for which there are weaker investor protections, or for markets that have lower disclosure standards. In general, the churn rate was higher as the quality of information and level of familiarity decreased. The authors found these results to:

".... be consistent with the hypothesis that the investors rebalance more often the holdings of stocks about which they know less and are less familiar with."

As might also be expected, the churn rate was higher in a foreign market if the market had performed well, with the rate increasing as the level of familiarity decreases. Similar to other markets, it seems that investors are likely to take profits after a market has run-up, and are much more likely to do so if the market is foreign, less transparent, and has a lower level of familiarity.