Trading Economics

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The Geography of Investment


The financial and investment market are co-depended on many factors, and geographic location is sometimes part of the deal, along with informed trading and asset prices. A study by Professor Joshua D. Coval and his Associates proved that geographical proximity increases the prospects of investments in mutual funds. Geographically proximate investments proved to be very lucrative for mutual fund managers, especially if the fund is actively managed since they make use of the information they can obtain in their local environment. Managers can make high returns out of local investments and holdings which come in a form of compensation for information they get from local companies. Exploitation of local knowledge can serve as a springboard for better investment decisions. Several funds are especially better off with this tactic, and those are smaller funds, older funds, and funds with only a few holdings. These target funds should invest in local holdings based on informed trading in order to achieve the maximum. Local investors should also aim at small cities or far-away areas where information can be easily obtained.

Active managers of mutual funds that do not invest in local holdings usually do not display abnormal performance, whereas those who have a strong local bias proved to make significant returns. A strong local bias is defined when managers invest 20%-25% of the funds’ assets into local companies. Local investments, based on statistical studies, outperform distant holdings by 3% on average which is a strong indicator of how local stocks can benefit the manager and their clients.

On an annual basis, a fund manager gets 2.67% more in returns from local stocks than distant stocks. The distance of local investments encompasses a 100-kilometer area from the fund location. It is easier to assess the risks, the price movements and stock value in a familiar location than somewhere else, and the knowledge results in better assessments of where to invest the assets.

Many have feared that the economic performance of the stocks in which the mutual fund managers invested would be short-lived and that they could drop in value after investments. Nevertheless, the detailed analysis of Joshua D. Coval and Co. showed that most of the times the local stocks are likely to keep up with the market and the team also proved that, on a long-term basis, local stocks are one step ahead of distant stocks.

Informed Trading

A series of empirical studies has shown that trading volume includes information on future returns and that it represents a great predictability factor, but economic specials do not have to rely only on that, they can reach for other strategies as well. For example informed trading is a great strategy, and it is also somehow related to stock returns given that all economy factors are interrelated.

Investors who reside near investment areas have better skills to select an asset for investment. The geographical proximity gives them the advantage to base their decisions on informed trading. Now let us analyze the correlation between local investor holding and asset prices.

The risk-adjustment for local stocks in the market is put at 1.1% on an annual basis, but yet smaller companies and firms which are in the ownership of mutual funds can even be exposed to a 3% annual risk. These data let us suggest that asset prices are correlated to geographic location and informed trading.

Informal trading helps fund managers also to assess which local stocks are not performing well and therefore should be avoided. As they get information on good stocks, they also get information on bad stocks and underperforming companies, which also would not be possible if it weren’t for geographic proximity.