International Portfolio Allocation Research Articles

Uncertainty and international fund flows: A cross-country analysis

This paper investigates the impacts of uncertainty on international portfolio allocation decisions and returns across 27 countries. Using panel structural vector autoregressive analysis, a positive link between both country-level and global uncertainty with equity fund flows is uncovered, highlighting the role of investor sentiment in capital allocation decisions. Findings also support the portfolio rebalancing theory, revealing the negative influence of past returns on fund flows. Results show that the VIX demonstrates a positive association with fund flows, particularly during periods of elevated global uncertainty. Moreover, this research analyzes differences between developed and emerging markets in their sensitivity to uncertainty shocks.

Anti‐dumping Policies and International Portfolio Allocation: The View from the Global Funds

AbstractAnti‐dumping policies, as one of the most important nontariff measures to protect a country's economic interests, can have an impact not only on a country's trade and social welfare, but also on capital flows. Anti‐dumping measures can result in increased trade costs and alterations to exchange rate risk. This study investigates the impact of anti‐dumping sanctions on the international portfolio allocations of global funds. Antidumping policies can decrease the proportion of a fund's investment portfolio allocated to recently‐sanctioned countries. Closer trade ties between the sanctioned country and the country where a fund is domiciled exacerbate the divestiture, but stronger foreign direct investment links weaken the negative association. Some country and fund heterogeneities are also discussed. We find that more developed countries are less affected by the impact of anti‐dumping measures on equity fund allocations; liberalization of the economy and stable government could also mitigate the negative impact of anti‐dumping sanctions. High‐risk funds, such as growth funds or funds that invest in leveraged buyouts, showed the greatest response to changes in anti‐dumping regulations.

A study on equity home bias using vine copula approach

The study investigates if the mean-downside risk optimization technique for asset allocation can shed new light on the equity home bias puzzle. We propose a combined EGARCH-EVT-C-vine copula approach to properly capture the stylized properties of asset return series and estimate the downside risk appropriately by CVaR. Using weekly stock price data from 12 countries including seven G7 countries and five BRICS countries, we estimate international portfolio allocations based on mean-CVaR optimization model and compare the results to the mean–variance allocations. The study has been done from the perspective of US investors. The results of the study suggest that the US equity home bias is overestimated by the mean–variance approach. The mean-CVaR model helps to factor in the additional risk that investors face in international portfolio diversification and provides a plausible empirical explanation for the equity home bias phenomenon. The findings of the study have direct implications for portfolio managers and investors for taking better international investment decisions based on the knowledge of optimum portfolio.

International portfolio diversification and genetic relatedness

The purpose of this paper is to shed some light on how relatedness between counterparties can explain investment behavior, specifically how much can investor’s inherited traits influence the exchange of capital. We use the genetic distance index and regress it against the foreign bias measure on pairs from 40 countries on a time period from 2001-2016. We identify that the prior exerts a significant impact on foreign investment decision, even when controlling for previous documented determinants of foreign bias. These findings reflect that international portfolio allocation is obstructed by the cultural wedge created between source and destination country, since relative difference in these characteristics disturb the flow of equity investments across markets, which ultimately hinder diversification.

International portfolio allocation: The role of conditional higher moments

I explore the benefits of incorporating conditional higher moments in the international portfolio allocation. The quantile-based conditional higher moments are robust to outliers and exhibit considerable time-variation and heterogeneity across countries. My empirical evidence shows that emerging market returns have favourable conditional skewness but are more exposed to extreme returns with higher kurtosis. In the international portfolio, the investor tilts her portfolio towards countries with higher skewness and less kurtosis, consistent with her moment preference in theory. An investor with moderate risk aversion would be willing to pay 210 basis points per year to switch from a three-moment portfolio to the portfolio that employs both conditional skewness and kurtosis. The portfolio policy is robust to real-time investing strategy and incorporating transaction costs, but the optimised portfolios underperform the naive value-weighted portfolio out-of-sample.

La structure des taux revisitée pour période de crise : entre contagion, flight to quality et quantitative easing

Cet article cherche à évaluer le rôle spécifique des risques de volatilité et de covolatilité dans la formation des taux d’intérêt à long terme de la zone euro sur les périodes de crise et post-crise, marquées par un rôle actif de la BCE. On propose pour cela un modèle de choix de portefeuille obligataire à deux pays qui permet de généraliser les résultats de la théorie traditionnelle de la structure par terme des taux d’intérêt. Les taux longs d’équilibre dépendent crucialement des covariances anticipées par les investisseurs sur les rendements obligataires. Des covariances anticipées positives amplifient les phénomènes de contagion par les fondamentaux en cas de dégradation des finances publiques, tandis que des covariances négatives amplifient les phénomènes de flight to quality . Le modèle est estimé économétriquement dans un cadre GARCH bivarié sur 21 paires de marchés obligataires souverains observés sur la période janvier 2006-septembre 2016. Cette évaluation empirique fait ressortir trois résultats importants. 1) La baisse des taux longs allemand et français très tôt dans la crise, à partir de mars 2011, a trouvé un support important dans la baisse des covariances anticipées vis-à-vis des pays périphériques, qui a véritablement amplifié le processus de flight to quality . 2) La logique des choix de portefeuilles optimaux, révélée par la sensibilité des taux longs aux risques de volatilité, semble disparaître pendant la crise pour réapparaître ensuite, à partir de la mise en place de l’OMT. 3) Un test à la Forbes et Rigobon [2002] sur les composantes non fondamentales des taux longs ne permet pas de conclure que le QE de la BCE, à partir de mars 2015, a véritablement entraîné une re-corrélation des marchés obligataires de la zone euro. Ce paradoxe s’explique par le fait que ces corrélations étaient déjà en moyenne élevées à la suite de l’OMT.

Practical Applications of International Equity Investing:International Equity Investing: Is Flexibility the New Diversification?

Practical Applications Summary In International Equity Investing: Is Flexibility the New Diversification?, from the September 2019 issue of The Journal of Portfolio Management, Sunder Ramkumar, Michelle Black, and Vincent Fu (all of Capital Group) investigate the effects of geographical restrictions on US mutual fund performance. They find that, in the face of increased correlation of equities around the world, investment strategies with fewer geographical restrictions perform better than traditional international portfolio allocations designed to offset risk in US domestic investments. The authors attribute this enhanced performance to a wider opportunity and greater flexibility among managers. “We argue that the case for international investing increasingly rests on the return potential from investing in a broad set of companies and that flexibility to invest across borders is key to capturing this value,” they write.

The Determinants of China’s International Portfolio Equity Allocations

We analyze shifts in the structure of China’s capital outflows over the past decade. The composition of gross outflows has shifted from accumulation of foreign exchange reserves by the central bank to non-official outflows. Unlocking the enormous pool of domestic savings could have a significant impact on global financial markets as China continues to open up its capital account and as domestic investors look abroad for returns and diversification. We analyze in detail the allocation patterns of Chinese institutional investors (IIs), which constitute the main channel for foreign portfolio investment outflows. We find that, relative to benchmarks based on market capitalization, Chinese IIs underweight developed countries and high-tech sectors, respectively, in their international portfolio allocations but overinvest in high-tech stocks in developed countries. To further examine Chinese IIs’ joint decisions on destination country–sector pairs, we construct continuous measures of revealed comparative advantage and disadvantage in a sector for a country based on trade patterns. We find that, in their foreign portfolio allocations, Chinese IIs overweight sectors in which China has a comparative disadvantage. Moreover, Chinese IIs concentrate such investments in countries that have higher comparative advantage in those sectors. Diversification and information advantages related to foreign imports to China seem to influence patterns of foreign portfolio allocations, while yield-seeking and learning motives do not.

The Determinants of China's International Portfolio Equity Allocations

We analyze shifts in the structure of China's capital outflows over the past decade. The composition of gross outflows has shifted from accumulation of foreign exchange reserves by the central bank to nonofficial outflows. Unlocking the enormous pool of domestic savings could have a significant impact on global financial markets as China continues to open up its capital account and as domestic investors look abroad for returns and diversification. We analyze in detail the allocation patterns of Chinese institutional investors (IIs), which constitute the main channel for foreign portfolio investment outflows. We find that, relative to benchmarks based on market capitalization, Chinese IIs underweight developed countries and high-tech sectors in their international portfolio allocations but overinvest in high-tech stocks in developed countries. To further examine Chinese IIs' joint decisions on destination country-sector pairs, we construct continuous measures of revealed relative comparative advantage and disadvantage in a sector for a country based on trade patterns. We find that, in their foreign portfolio allocations, Chinese IIs overweight sectors in which China has a comparative disadvantage. Moreover, Chinese IIs concentrate such investments in countries that have higher relative comparative advantage in those sectors. Diversification and information advantages related to foreign imports to China seem to influence patterns of foreign portfolio allocations, while yield-seeking and learning motives do not.

International Portfolio Allocation: The Role of Conditional Higher Moments

I explore the benefits of incorporating conditional higher moments in the international portfolio allocation. The quantile-based conditional higher moments are robust to the outliers and exhibit considerable time-variation and heterogeneity across countries. My empirical evidence shows that emerging market returns have favourable conditional skewness but are more exposed to extreme returns with higher kurtosis. In the international portfolio, the investor tilts her portfolio towards countries with higher skewness and less kurtosis, consistent with her moment preference in theory. An investor with moderate risk aversion would be willing to pay 210 basis points per year to switch from a three-moment portfolio to the portfolio that employs both conditional skewness and kurtosis. The results are robust to real-time investing strategy, transaction costs and alternative model specifications.

The Coming Wave: Where Do Emerging Market Investors Put Their Money?

Using country- and institution-level data, we find that the “coming wave” of emerging- market (EM) investors systematically over- or underweight their equity portfolio holdings in a way that reflects the influences of past capital and trade flows from a foreign country. We interpret this finding as support for van Nieuwerburgh and Veldkamp (2009) information endowment hypothesis. Strong past capital and trade flows create an information advantage that leads EM investors to disproportionately overweight a given foreign market, even relative to developed market investor counterparts. We also pursue predictions of the information endowment hypothesis by constructing novel information-advantage proxies based on relationships among investment firms and the headquarters of their parent companies. These proxies also offer reliable explanatory power for international portfolio allocations.

China's Impact on Global Financial Markets

We analyze shifts in the structure of China’s capital outflows over the past decade. The composition of gross outflows has shifted from accumulation of foreign exchange reserves by the central bank to nonofficial outflows. Unlocking the enormous pool of domestic savings could have a significant impact on global financial markets as China continues to open up its capital account and as domestic investors look abroad for returns and diversification. We analyze in detail the allocation patterns of Chinese institutional investors (IIs), which constitute the main channel for foreign portfolio investment outflows. We find that, relative to benchmarks based on market capitalization, Chinese IIs underweight developed countries and high-tech sectors in their international portfolio allocations but overinvest in high-tech stocks in developed countries. To further examine Chinese IIs’ joint decisions on destination country-sector pairs, we construct continuous measures of revealed relative comparative advantage and disadvantage in a sector for a country based on trade patterns. We find that, in their foreign portfolio allocations, Chinese IIs overweight sectors in which China has a comparative disadvantage. Moreover, Chinese IIs concentrate such investments in countries that have higher relative comparative advantage in those sectors. Diversification and information advantages related to foreign imports to China seem to influence patterns of foreign portfolio allocations, while yield-seeking and learning motives do not.

Biases in international portfolio allocation and investor protection standards

Economic reasoning suggests that financial globalization that encourages optimal international portfolio investments should improve investor protection standards (IPS) of a country. In practice, however, investors manifest varying degrees of suboptimal international portfolio allocations. Using a panel dataset covering 44 countries spanning over 15years we examine whether suboptimal equity portfolio allocation in part is associated with the cross-country variations in IPS. Consistent with economic reasoning we find robust indications that international portfolio allocation may play an important role in the development of IPS. More specifically, the quality of IPS improves with higher degrees of optimal international equity portfolio allocation of domestic and foreign investors.

Gradual Portfolio Adjustment: Implications for Global Equity Portfolios and Returns

Modern open economy macro models assume the continuous adjustment of international portfolio allocation. We introduce gradual portfolio adjustment into a global equity market model. Our approach differs from related literature in two key dimensions. First, the time interval between portfolio decisions is stochastic rather than fixed, leading to a smoother response to shocks. Second, rather than only considering asset returns, we also use data on portfolio shares to confront the model to the data. Conditional on reasonable risk aversion, we find that the data is consistent with infrequent portfolio decisions, with a frequency of at most once in 15 months on average.

Biases in International Portfolio Allocation and Investor Protection Standards

Economic reasoning suggests that financial globalization that encourages optimal international portfolio investments should improve investor protection standards (IPS) of a country. In practice, however, investors manifest varying degrees of suboptimal international portfolio allocations. Using a panel dataset covering 44 countries spanning over 15 years we examine whether suboptimal equity portfolio allocation in part is associated with the cross-country variations in IPS. Consistent with economic reasoning we find robust indications that international portfolio allocation may play an important role in the development of IPS. More specifically, the quality of IPS improves with higher degrees of optimal international equity portfolio allocation of domestic and foreign investors.

Gradual Portfolio Adjustment: Implications for Global Equity Portfolios and Returns

Modern open economy macro models assume the continuous adjustment of international portfolio allocation. We introduce gradual portfolio adjustment into a global equity market model. Our approach differs from related literature in two key dimensions. First, the time interval between portfolio decisions is stochastic rather than fixed, leading to a smoother response to shocks. Second, rather than only considering asset returns, we also use data on portfolio shares to confront the model to the data. Conditional on reasonable risk aversion, we find that the data is consistent with infrequent portfolio decisions, with a frequency of at most once in 15 months on average.

Sub-optimal international portfolio allocations and the cost of capital

Finance theory suggests that the optimal international equity portfolio investment by home and foreign investors reduces the cost of capital through international risk sharing and capital market integration. However, the empirical evidence is inconsistent with theory as a number of studies show investors exhibit cross-country biases in their international portfolio investments, known as home and foreign biases. In this study we investigate the implications of home and foreign biases on the cost of capital. Using data from 44 countries over the period 2001–2014, we provide strong evidence that countries that experience higher home bias are associated with a higher cost of capital. Similarly, we also find that countries that are more favoured by foreign investors, relative to the theoretical predictions, are associated with a lower cost of capital.

The Coming Wave: Where Do Emerging Market Investors Put Their Money?

We examine how emerging market (EM) investors allocate their stock portfolios internationally. Using both country-level and institution-level data, we find that the coming wave of EM investors systematically over- and under-weight their holdings in some target countries. These abnormal foreign allocation biases of EM investors offer robust support of the information endowment hypothesis of van Nieuwerburgh and Veldkamp (2009). Specifically, past capital and trade flows from a foreign country to the home country create an information endowment (or advantage) that lead home country investments to be overweight that foreign country. At the institutional level, information advantage proxies based on relationships between EM institutional investors and the headquarters of their parent companies have strong explanatory power for international portfolio allocations. The results remain robust after controlling for other factors like geographic and other measures of economic proximity, economic and capital market development, market integration, market returns and correlation, and corporate governance. The information advantage effect is stronger for EM investors for which external portfolios exhibit a higher degree of concentration.

The Coming Wave: Where Do Emerging Market Investors Put Their Money?

Using country- and institution-level data, we find that the “coming wave” of emerging- market (EM) investors systematically over- or underweight their equity portfolio holdings in a way that reflects the influences of past capital and trade flows from a foreign country. We interpret this finding as support for van Nieuwerburgh and Veldkamp (2009) information endowment hypothesis. Strong past capital and trade flows create an information advantage that leads EM investors to disproportionately overweight a given foreign market, even relative to developed market investor counterparts. We also pursue predictions of the information endowment hypothesis by constructing novel information-advantage proxies based on relationships among investment firms and the headquarters of their parent companies. These proxies also offer reliable explanatory power for international portfolio allocations.

Access to information and international portfolio allocation

We examine whether foreign equity holdings of portfolio investors depend on the level of information accessibility between the investors’ home and host countries. Using a comprehensive data set, alternative measures of information accessibility and robust analytical techniques, we show that differences in access to cross-country information significantly influence investors’ portfolio allocation decisions. Furthermore, the results suggest that for a given level of access to information, investors prefer to invest more in countries with a higher quality of legal/macro-institutions. Finally, the findings also confirm that the implications of information accessibility are more pronounced when markets are turbulent.