It is now generally accepted that information asymmetry that exists among different types of investors is one of the key explanatory factors of stock market behavior, especially if such asymmetry involves huge trading volumes or extreme market volatility. When a stock market is actively driven by investors who are both well- and mis-informed, it should be an important issue in financial literature to identify the characteristics of the informed investors. Taking advantage of the trend of globalization particularly in emerging markets, foreign investors have played an important role. Grinblatt and Keloharju (2004) and Kamesaka et al. (2003) report that foreign investors outperform domestic investors significantly in some stock markets such as in Finland and in Japan. Their results imply that foreign investors are typically better informed traders than domestic investors in such markets. In addition, Dvorak (2005) compares the 'per market transaction profit' of domestic investors with that of foreign investors to examine which group of investors was more informed. In this paper, however, we attempt to show that a group of investors with high 'per market transaction profits' may achieve lower cumulative returns than the group of investors who have low 'per market transaction profits'. Hence the 'per market transaction profit' should not be a good measure of informational advantage. Since a necessary condition to be an informed investor is that he generates profit by trading stocks, the best way to inspect whether a group of investors is informed is to look into its cumulative return for a reasonably long period of time. In this respect, we propose using the 'cumulative return' as an alternative measure to 'per market transaction profit' in comparing informational advantages of each type of investors. To show that, we divide all the investors into two groups: foreign investors and domestic investors. We precisely calculate the cumulative returns of each group employing two sets of data that run from January 3, 2000 to December 28, 2005. One data set covers the transactions of the largest 100 stocks listed on the KRX (Korea Exchange) in the tick data form, and the other contains information regarding the daily level of stock holdings for each investor group. Covering the 6 year period from 2000 to 2005, <table 4.1> shows that the cumulative return on stock investment of foreign investors is about 82.6%, while that of domestic investors is about 21.9%. This gap in performance implies that foreign investors take up a larger proportion of the informed traders than the domestic investors do. In order to identify the determinants of cumulative return, we decompose the cumulative return into three mutually exclusive components: an asset allocation component, a portfolio recomposition component, and an intra-day trading component. The asset allocation component is obtained by subtracting the time weighted rate of return (TWRR) from the cumulative return. Since TWRR is defined as the return on investment by assuming that interim cash flows under management are zero, the asset allocation component measures what additional interim cash flows have taken place because of the asset allocation decisions. The intra-day trading component measures the share of profit generated by intra-day trading to the cumulative return. The portfolio recomposition. component is determined by subtracting the intra-day trading component from the TWRR. This measures the share of profit generated by the inter-day price change to the cumulative return. By probing each component's proportion to the cumulative return, we can infer what the major sources of investor returns are and where their informational advantages come from. <table 4.1> shows that foreign investors have outperformed domestic investors in each component. For example, for the 6 year period, the foreign investor asset allocation component, portfolio recomposition component, and intra-day trading component record 29.3%, 52.5%, and 0.8%, respectively, while those of domestic investors are -15.5%, 38.0%, and -0.5%, respectively. Among the three components the largest difference between the two groups of investors occurs at the asset allocation component, which means that compared to domestic investors foreign investors enjoy more informational advantages especially in those factors related with asset allocation strategies. We applied risk adjusting process to the returns of the portfolio recomposition component using the market model and the 3 factor model and tested whether there is any significant difference in the risk adjusted returns between the two groups. <table 4.6> shows that there is no significant difference in the risk adjusted return between the investor groups irrespective of the risk adjusting model. This can be interpreted that it is not the informational advantage in constructing stock portfolio that determines the superior performance of foreign investors but the informational advantage in their asset allocation strategies.
