IJE : Volume 8 • Number 2 • December 2014, pp. 173-178

Performance of International Capital in the Taiwanese Stock Market Tzu-Yi Yang* and Yu-Tai Yang** Abstract: This paper studies the performance of international capital in the Taiwanese stock market from January 1995 to November 2010. This study uses data of listed companies with investment from international capital to measure the performance of international capital in the Taiwanese stock market using the CAPM model. The empirical results show that international capital investment in the Taiwanese stock market outperforms the overall market, particularly during periods of economic growth. Key words: Mutual fund, performance, behavioral finance, financial crisis, Taiwan, and stock market. INTRODUCTION

International capital remains a robust and integral component of the Taiwanese investment environment and has been increasing for many years. International capital resembles a growing snowball, and commentators must not ignore its influence. International capital unquestionably strongly influences the global economy. According to emerging portfolio research statistics, international capital totaled 5 trillion U.S. dollars in 2005, and the family number has reached as high as 100,000,000. Assuming international capital shares certain behavioral patterns, it undoubtedly strongly influences a country. Therefore, studying the reasons for the behavior and performance of international capital is worthwhile. Understanding the behavioral characteristics of international capital makes it possible to devise appropriate and natural means of controlling international capital, which left unchecked can destroy an economy. Inflow behavior can clarify whether movements of international capital influence investment returns. Annual net inflows of international capital into Taiwan have occurred every year since 1995, and since 2004 total international capital invested in Taiwan has exceeded 35% of total international capital invested in Asian emerging markets. Given the strong presence of international capital in Taiwan, it is important to identify the impact of this category of capital on market performance. Meanwhile, this study finds that capital flow and investment *

Department of Business and Management, Ming Chi University of Technology, No.84, Gongjuan Rd., Taishan Dist., New Taipei City 24301, Taiwan, E-mail: [email protected]

**

Department of aircraft engineering, Army Academic R.O.C., No.750, Longdong Rd., Zhongli City, Taoyuan County 320, Taiwan (R.O.C.), E-mail: [email protected]

The authors are greatly thankful for the valuable comments and suggestions offered by two anonymous referees. Any errors or omissions are entirely the authors’. We are grateful to the financial support by the National Science Council, R.O.C., under Grant No. NSC99-2410-H-146-002

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performance differ between individual investor capital and international capital, a finding that offers potential for individual investors to modify their own investment behavior to maximize investment performance. LITERATURE REVIEW

In Taiwan, international capital has become a popular product because of offering advantages, such as time-saving, convenience, etc. The new trend has increased the appreciable funds. According to Asiaweek (2001), stock markets in emerging Asian economies like Taiwan, Indonesia, India, Malaysia, and the Philippines anticipate double digit annual growth and are predicted to reach total capitalization of U.S. $12 trillion by the year 2030. Thus, the performance of international capital is important for portfolio managers. Relative performance of international versus domestic portfolios is important in attracting investment funds from individual investors. As Santini and Aber (1998) notes, the Sharp measure (SH) and return in excess of the short-term rate (MXSHORT) can accurately describe fund performance, and new money flows are positive and significant from the first quarter of 1973 to the third quarter of 1985, based on a sample of 127 open-end equity international capital funds. Since fund performance is related to capital inflow behavior, Silva, Sapra, and Thorley (2001) measure the performance of international capital compared to the stock index and find that the returns of international capital exceed index returns using the argument of Sharpe about the link of average returns on stocks and funds with dispersion of returns on stock and funds. They use the CRSP Center for Research on Security Prices database, which contains returns on all U.S. stocks from the National Association of Securities Dealers Automated Quotation (NASDAQ) Shares during 1926 – 1973, and on Amex Shares during 1926-1963. International capital outperforms the stock market (Change 1996). Change examines whether international capital outperforms the overall stock market by applying the Market Return and Wilcoxon methods to three different stock markets in Taiwan, thus providing investors with reference data. Furthermore, Change tested whether international capital outperforms the market and domestic capital using the methods of Sharpe, Treynor and Jenson. Change finds that international capital outperforms the market. Finally, used the independent test method to examine whether daily movement of indices is significantly related to daily overbuy and oversell volumes. The empirical results showed that international capital outperforms the market during both regular and secular bear markets. Meanwhile, international capital underperforms during bull markets. Additionally, the stock with the highest previous day net buy volume from international capital outperforms in all markets, whether bull, bear or secular bear. Therefore, investors can achieve outsized returns in bull and secular bear markets, but not in regular bear markets, simply by following international capital and buying stocks with the highest previous day net buying by international capital. Kuo and Chi (2000) obtain similar results to those describe above. Specifically, Kuo and Chi survey the 30 Taiwan companies with the largest investment by international capital and divided them into pre-crisis, on-crisis, and post-crisis groups. They use return and volatility models to study whether international capital herding behavior induces better investment performance relative to the overall Taiwanese stock market, with the aim of providing investors

Performance of International Capital in the Taiwanese Stock Market � 175

reference data. The results demonstrate that international capital outperforms the index, particularly during the financial crisis period. Thus, they suggested investors respond to high uncertainty by following the investment patterns of international capital. However, previous studies have also pointed out that the performance of international capital relative to the market varies among different areas. For example, Chang and Kolodny (1995) demonstrate that 15 closed-end country funds underperformed the Morgan Stanley Capital International (MSCI) world market index during the testing period from 1989 to 1990, with the Mexico Fund being the only exception. Meanwhile, Gallo and Swanson (1996) reported that open-end international funds in the U.S. underperformed the Morgan Stanley Capital International index. Patro (2001) explicitly state that outcomes vary among sample periods. Patro (2001) point o that the net asset values (NAVs) or shares of 45 U.S. based international closed-end funds underperform their local or world market indices over the testing period 1991-1997; this finding differs from his empirical result that the funds match global stock market performance during 1991-1997. Therefore, the present study attempts to provide a comprehensive empirical analysis of international capital performance. The literature reveals that performance varies according to area, sample time, and various other external factors. Thus, this study seeks robust information from Taiwan, a market neglected by previous researchers that portfolio managers and investors can use in selecting international capital. DATA AND METHOD

Numerous studies have observed the performance of international capital relative to stock market indices (Detzler, 1999; Campbell, Martin, Malkiel, and Xu, 2001). Some researchers, such as Cumby and Glen (1990), have found that open-end international funds in the U.S. underperform the market, while others, such as Gallo and Swanson (1996), who used a twofactor arbitrage pricing theory (APT) model, have found that international funds outperform. However, the performance of international capital in Taiwan remains unclear OR the previous literature has neglected the performance of international capital in Taiwan. Data used to examine international capital performance in Taiwan was collected from 1995 to November 2010, and was sourced from two databases, as follows: (1) Market returns of companies invested by international capital: Taiwan Economic Journal (TEJ) database. (2) Market returns of Taiwanese shares: Taiwan Economic Journal (TEJ) database. This study collected liquid market capitalization invested by international capital for individual companies listed on stock markets in Taiwan. The test period ran from 1995 to November 2010. EMPIRICAL MODELS

Sirri and Tufano (1998) find international capital investment funds in Taiwan are a positive relationship between new cash inflows to international investment funds and historical returns. Therefore, the models used in this study are based on the research of Karceski (2002), which

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applied the capital asset pricing model (CAPM) to find that market returns significantly impact subsequent aggregate international capital inflows. CAPM is an important financial model. CAPM explains variations in the rate of return on a security as a function of the rate of return of a portfolio entirely comprising publicly traded stocks. Models generally measure the rate of return on an investment relative to its systematic risk or risk premium - beta. The beta on a security is proportional to that on the market portfolio. The ordinary least squares (OLS) method examines overall fund performance following multiple injections of international capital. Numerous previous studies have investigated international capital performance via ordinary least squares regression analysis (Apap and Griffith, 1998; Peterson, Pietranico, Riepe, and Xu, 2002; Costa and Porter, 2003). This investigation uses the ordinary least squares method to examine the performance of international capital relative to the market. This section presents the standard CAPM model for comparing international capital performance to Taiwanese share market returns. The application of Model I to the Taiwanese stock market is expressed as follows: (I) ICt – Intt = � + �j (StockA,t – Intt) Where ICt and Intt are the returns to companies’ liquid market value invested by international capital during period t and the risk-free rate as 3-month certificates of deposit rate in period t; StockA,t is the return of the Taiwan share market in period t; �j is the systematic risk of asset j, and � is a constant. EMPIRICAL RESULTS

Model I analyzes international capital performance, and Table 1 lists the model results. Table 1 lists Taiwan stock market value returns (StockA) versus the liquid market value returns of companies] invested by international capital (IC). The table shows that Taiwanese stock market value (StockA ) returns increased by 1% and company liquid market value returns invested by international capital (IC) increased 1.083%. International capital on the Taiwan stock market outperforms the index, indicating that the Taiwan stock market is an attractive investment destination for international capital. Numerous reasons exist for this phenomenon, including different international capital managers have different choosing ability, professional knowledge, or extraneous factors. CONCLUSIONS

This study documented the performance of international capital in the Taiwanese stock market and obtained similar findings to several other empirical studies (Cumby and Glen, 1990; Chang et al., 1995; Gallo and Swanson, 1996). This study shows that international capital outperforms the market in Taiwan, and thus provides useful signals for investors. Fund managers manage funds with the aim of making returns and creating a record of outperformance, thus attracting more funds to their management. Thus, fund managers require either have a detailed understanding of the nature of a fund or some specialized stock selection ability. Despite the economic opening of Taiwan and annual growth in gross domestic product, Taiwanese citizens continue to invest in the Taiwanese stock market via international capital

Performance of International Capital in the Taiwanese Stock Market � 177 Table 1 Regression Analysis of International Capital Performance

Taiwan International capitals’ Performance StockA

1.0837 (0.0379)**

Adjusted R2

0.8112

Observations

191

Note1: Stock A

are returns of Taiwan stock market value.

Note2: Depend variables are companies’ liquid market value returns invested by international capitals. Note3: The figure in parenthesis represents stand deviation value; *, **, *** represent 10%, 5%, and 1% significant level. Note4: The test period is from 1995 to November 2010. Note5: Adjusted R2 data is for comparison of model fit from year to year. managers, since they are in the era of people buying stocks and people losing stocks. During this period Taiwanese have tended to invest in the stock market via international capital managers rather than directly, motivated by lower risk, smaller handling fees, and larger returns. The analytical results demonstrate that international capital outperforms the index in the Taiwan stock market, particularly during periods of strong economic growth. This information is of significant practical use for investors. References Apap, A. and Griffith, J. M. (1998), The impact of expenses on equity mutual fund performance. Journal of Financial Planning, 11(1): 76-81. Asiaweek (2001), 4 May. Campbell, J. Y., Martin, L., Malkiel, B. G., and Xu, Y. (2001), Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk. Jornal of Finance, 56 (1): 1-43. Chang, E., Eun, C., and Kolodny, R. (1995), International diversification through closed-end country funds. Journal of Banking and Finance, 19: 1237-1263.

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Change, M. (1996), The Reference Value of Foreign Capital’s Overbuy and Oversell Information. Master Thesis, University of National Chung Hsing, TW Costa, B. A. and Porter, G. E. (2003), Mutual fund managers: Does longevity implyexpertise? Journal of Economics and Finance, 27(2): 224-235. Cumby, R. and Glen, J. (1990), Evaluation the performance of international mutual funds. Journal of Finance, 45 (2): 497-521. Detaler, M. L. (1999), The performance of global bond mutual funds. Journal of Banking and Finance, 23: 1195-1217. Gallo, J. and Swanson, P. (1996), Comparative measures of performance for US-based international equity mutual funds. Journal of Banking and Finance, 20: 1635-1650. Karceski, J. (2002), Returns-chasing behavior, mutual funds, and beta’s death. Journal of Financial and Quantitative Analysis, 37(4): 559-594. Kuo, M. H. and Chi, C. C. (2000), The Investment Behavior and Performance Around the Asian Financial Crisis: Foreign Investment Institutions in Taiwan. Management Review, 19(1): 81-118. (in Chinese) Patro, D. K. (2001), Measuring performance of international closed-end funds. Journal of Banking and Finance, 25: 1741-1767. Peterson, J. D., Pietranico, P. A., Riepe, M. W., and Xu, F. (2002), Explaining after-tax mutual fund performance. Financial Analysts Journal, 58(1): 75-86. Santini, D. L. and Aber, J. W., (1998), Determinants of net new money flows to the equity mutual fund industry. Journal of Economics and Business, 50(5): 419-429. Silva, H. D., Sapra, S. S., and Thorley, S. (2001) Return dispersion and active management. Financial Analysts Journal, 57 (5): 29-42. Sirri, E. R. and Tufano, P. (1998), Costly Search and Mutual Fund Flows. Journal of Finance, 53: 15891622.