Equity Investment by Global Funds: Return and Sovereign Risk

Abstract

We examine the rate of return earned by global funds on equity investment in emerging markets (EMs) particularly the role played by sovereign credit risk. Changes in sovereign credit ratings (upgrades/downgrades) influence excess (over risk free rate) returns earned by foreign investors: lower excess returns are associated with lower risk. The effect of credit upgrades and downgrades, however, is not symmetric. By contrast, credit outlook or credit watch announcements do not seem to influence foreign investors’ excess returns. When it comes to abnormal (risk-adjusted) returns, foreign investors treat the information contained in credit rating announcements differently from that in outlook/watch announcements. The differing effect of these two is not evident for the risk-adjusted returns of domestic stock market indexes. There is evidence, however, that the behavior of foreign investors influences significantly the risk-adjusted returns of EM stock market indexes.