Shane Underwood: Implementing Direct Flights Changes the Investment Game
November 30, 2020
How does geographical proximity matter to investing? For years, studies had
shown mutual funds were more likely to invest in a firm that was close by, as
well as the fund being more likely to invest a larger dollar amount in the said
firm as well.
This may seem obvious to some people, Shane Underwood, professor of Finance and
Chair of the Department of Finance, Insurance, and Real Estate at Baylor
University's Hankamer School of Business, said. There is a local advantage due
to local knowledge, he said, but does being local actually lead to success?
"Say you are a mutual fund in Boston that is investing in a firm in Boston or
nearby," Underwood said. "You do not know whether it is really the closeness—the
fact that you are close that is leading you to invest more and have an
informational advantage—or is it some other factor that led you to locate in
This unknown is something Underwood refers to as an endogeneity problem in the
article "The Causal Effects of Proximity on Investments: Evidence from Flight
Introductions," written by Underwood, Jesse Ellis of North Carolina State
University and Leonardo Madureira of Case Western Reserve University and
published in the Journal of Financial and Quantitative Analysis.
To overcome the endogeneity issues in previous literature, Underwood and the
research team shifted the idea of proximity from geographic distance to that of
travel time. The introduction of a direct flight between two cities could
present an opportunity for decreased travel time and open the door for funds in
Boston to interact with firms in Los Angeles and vice versa, Underwood said.
The research team tracked the monthly performance of funds and returns for the
firms differing Metropolitan Statistical Areas (MSAs). Additionally, the Federal
Aviation Administration (FAA) data was used to track the introduction of direct
flights between MSAs. This twist in the methodology allowed the team to more
cleanly test whether proximity affects investment decisions and performance.
Underwood and the team discovered that when a direct flight was introduced that
decreased the travel time between a fund and a firm, fund managers were more
likely to invest more and they received an informational advantage upon getting
"It becomes easier for fund managers to visit a firm and have quality
conversations which help them perform well as investors," Underwood said.
In an age when firm information is easily obtainable, some may think
face-to-face visits are unnecessary, Underwood said. It is possible to gather
all the information you need on a firm and talk over the phone or through video
chats, but this research hints at the opposite, he said. Instead of staying far
away, the face-to-face interaction between fund managers and firms increased the
likelihood of investment and improved return on holdings. It comes down to a
level of trust, he said, but that is something that would require additional
The informational knowledge gained through decreased travel time is very
beneficial to a fund manager, Underwood said. However, one limitation of the
study is the inability to pin down the source of the advantage. This was a
significant concern raised during the review process, but Underwood believes
there are a few possible answers.
"It could be that I am getting the informational advantage because I can go
visit the firm, ask the CEO questions and other important aspects," he said. "Or
it could be that because I am close and making these visits, their behavior
Without having documentation of company visits and how often they occurred, it
is very difficult to truly identify the source. Yet, this difficulty opens up
avenues for future research.
The results are not surprising, nor will they change how portfolios continue to
be set up, Underwood said. The significance of the study lies in the
"If you believe our results, then it should matter if part of the mutual fund's
strategy is to visit firms and to get to know the management," he said. "We
could just program a computer to pick stocks for us and there are some
reasonable approaches to doing that. But this says ‘No, the face-to-face still