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On the International Transmission of Shocks: Micro-Evidence from Mutual Fund Portfolios Claudio Raddatz Sergio On the International Transmission of Shocks: Micro-Evidence from Mutual Fund Portfolios Claudio Raddatz Sergio Schmukler Central Bank of Chile The World Bank Debt and Credit, Growth and Crises Banco de España-World Bank Conference June 18 & 19, 2012

I. Motivation § Volatile capital flows, intermediated by financial intermediaries (FI) § Need to I. Motivation § Volatile capital flows, intermediated by financial intermediaries (FI) § Need to understand FI and the micro aspects of their behavior § In particular, do FI make capital flows more volatile and pro-cyclical? § Ex-ante risk taking behavior that generate crises § Ex-post propagation of shocks across markets and countries (Q and P) § Intermediaries face principal agent problems that affect allocations § [Underlying Investors FI Agents (Managers)] Assets § Limited evidence on inner-workings of FI at international level § Aggregate investments x-countries, by foreign & domestic agents, and certain intermediaries (mostly banks)

I. Motivation: This Paper How do underlying investors and managers behave, react to shocks, I. Motivation: This Paper How do underlying investors and managers behave, react to shocks, and contribute to transmit crises across countries? § Focus on international mutual funds § Increasingly important drivers of capital flows § Detailed micro-level portfolio data § More than 1, 000 equity and bond funds, monthly, starting 1996 § Disentangle the behavior of § Underlying investors (UI) by measuring injections/redemptions § Managers (M) by changes in country-portfolio weights and cash

I. Motivation: This Paper Allocations / Net Inflows Underlying investors Managers Injections / Redemptions I. Motivation: This Paper Allocations / Net Inflows Underlying investors Managers Injections / Redemptions Countr y 1 Countr yi Countr y. N Cash

I. Motivation: Specific questions § What is the contribution of injections to changes in I. Motivation: Specific questions § What is the contribution of injections to changes in MF investment? § Do managers significantly change country-portfolio weights over time? § What are the determinants of investor’s injections and manager’s portfolio allocations? § How do injections and allocations respond to crises? § At the country level, how much of the volatility of capital flows is driven by fund managers versus investors? § Are there differences between bond and equity funds?

Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Reallocations IV. Behavior of Investors and Managers V. Gross and Net Country Flows VI. Conclusions

II. Data: Micro-level Dataset on Mutual Funds: (EPFR ) § Data coverage (monthly frequency) II. Data: Micro-level Dataset on Mutual Funds: (EPFR ) § Data coverage (monthly frequency) § 1, 076 funds: global and EM funds § 965 equity funds: Jan 1996 -Nov 2010 § 111 bond funds: Jul 2002 -Nov 2010 § 7, 429, 000 obs. /weights across funds, 124 countries, and over time § Equity funds: 6, 867, 500 obs. § Bond funds: 561, 500 obs. § Variables § § § Total net assets (TNA) % of the funds’ assets allocated to each country and held in cash Investor type: active/passive Investment scopes (geographical regions) Others: fund domicile, family, main currency denomination

II. Data: Additional Data § Fund prices (NAV) § § 255, 510 obs. , II. Data: Additional Data § Fund prices (NAV) § § 255, 510 obs. , monthly basis 90% of matches with EPFR funds: 896 equity funds, 106 bond funds Sources: Bloomberg and Datastream Used to compute returns and injections to funds § Country stock and bond market indexes (U. S. dollars) 23, 272 obs. , monthly basis Equity markets: 86 countries, Jan 1999 -Nov 2010 Bond markets: 78 countries, Jul 2002 -Nov 2010 Sources: MSCI std. index, S&P BM index, local sources , JP Morgan sovereign bond index § Used to compute the flows to the countries § Use country-level indexes to compute returns at country level § §

II. Data: Summary and Main Variables II. Data: Summary and Main Variables

II. Evolution of Total Assets in Equity Funds 1996 -2000 2001 -2010 • Assets II. Evolution of Total Assets in Equity Funds 1996 -2000 2001 -2010 • Assets fluctuate importantly in expected manner (pro-cyclically ) • Driven by prices (returns from previous allocations) or injections?

II. Evolution of Portfolio Composition around the GFC Global Equity Funds Average portfolio shares II. Evolution of Portfolio Composition around the GFC Global Equity Funds Average portfolio shares

II. Evolution of Portfolio Composition around the GFC Global Emerging Equity Funds Average portfolio II. Evolution of Portfolio Composition around the GFC Global Emerging Equity Funds Average portfolio shares

II. Evolution of Portfolio Composition around the GFC Global Bond Funds Average portfolio shares II. Evolution of Portfolio Composition around the GFC Global Bond Funds Average portfolio shares

II. Evolution of Portfolio Composition around the GFC Cash Weights – Global Funds Average II. Evolution of Portfolio Composition around the GFC Cash Weights – Global Funds Average portfolio shares

Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Reallocations IV. Behavior of Investors and Managers V. Gross and Net Country Flows VI. Conclusions

III. Variation in Assets: Decomposition of Asset Growth Both injections and valuations matter III. Variation in Assets: Decomposition of Asset Growth Both injections and valuations matter

III. Variance Decomposition (Tranquil vs. Crisis Times) All Bond Funds Not driven by a III. Variance Decomposition (Tranquil vs. Crisis Times) All Bond Funds Not driven by a common time component

III. Significant Variation in Country Weights: Coefficients of Variation Manager’s decision on how to III. Significant Variation in Country Weights: Coefficients of Variation Manager’s decision on how to allocate flows may play an important role

Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Reallocations IV. Behavior of Investors and Managers V. Gross and Net Country Flows VI. Conclusions

IV. Behavior of Investors: Injections to Equity Funds A. Equity Funds Variables Country Crisis IV. Behavior of Investors: Injections to Equity Funds A. Equity Funds Variables Country Crisis Injections/Average Assets -0. 048* -0. 003 -0. 009 -0. 013 (0. 014) (0. 012) (0. 010) (0. 011) Global Crisis -0. 018* -0. 008† (0. 001) (0. 004) Lagged Fund Returns 0. 161* 0. 119* 0. 171* 0. 178* (0. 024) (0. 023) (0. 039) Country of Origin Returns 0. 261* 0. 222* 0. 135* (0. 024) (0. 023) (0. 028) Time Fixed Effects No No No Yes No Country of Origin-Time Fixed Effects No No No Yes No. of Observations R-squared Adj. R-sq 41, 232 40, 492 39, 479 38, 764 40, 492 0. 035 0. 016 0. 036 0. 017 0. 047 0. 028 0. 050 0. 031 Pro-cyclical and subject to wealth effects 0. 065 0. 046 0. 114 0. 092 0. 174 0. 090 *=1%, †=5%, ~=10%

IV. Behavior of Investors: Injections to Bond Funds B. Bond Funds Variables Country Crisis IV. Behavior of Investors: Injections to Bond Funds B. Bond Funds Variables Country Crisis Injections/Average Assets -0. 081* (0. 021) Global Crisis -0. 038* -0. 028* (0. 006) (0. 008) Lagged Fund Returns 0. 229† 0. 205† 0. 126~ 0. 107 (0. 111) Country of Origin Returns Time Fixed Effects No Country of Origin-Month Fixed Effects -0. 031 (0. 018) (0. 016) (0. 023) (0. 102) (0. 070) (0. 067) No (0. 148) (0. 127) (0. 121) No No Yes No No Yes No. of Observations 3, 520 3, 445 3, 261 3, 196 3, 445 R-squared 0. 061 0. 065 0. 073 0. 068 0. 092 0. 156 0. 266 Adj. R-sq 0. 038 0. 041 0. 051 0. 044 0. 069 0. 107 0. 087 Even more than equity funds 0. 464* -0. 018 0. 337* -0. 070* 0. 468* *=1%, †=5%, ~=10%

IV. Behavior of Managers: Framework § Behavior of (log) weights § Comes from log-linearization IV. Behavior of Managers: Framework § Behavior of (log) weights § Comes from log-linearization of identity § Plus an implicit flow equation

IV. Behavior of Managers: Framework § α and β = 1: buy-and-hold strategy § IV. Behavior of Managers: Framework § α and β = 1: buy-and-hold strategy § α and β ≠ 1: cyclicality of flows from managers to countries § β < 1 counter-cyclical relative flows § ϒ response of flows to a crisis (on top of what is captured by β) § Test for persistence of weights and response to returns and crises § Similar results if reallocations (relative to buy-and-hold) studied § Econometric considerations discussed in the paper § Dynamic panel, UR, Endogeneity

IV. Behavior of Managers: Country Weights A. Equity Funds Log Country Weights Monthly Semi IV. Behavior of Managers: Country Weights A. Equity Funds Log Country Weights Monthly Semi Annual 0. 983* 0. 901* 0. 568* 0. 899 * (0. 001) (0. 002) (0. 012) 0. 993* 0. 959* 0. 956* 0. 857* 0. 598 * (0. 013) (0. 049) (0. 013) (0. 032) -0. 020* -0. 069* (0. 003) (0. 017) No No No Annual 0. 307* (0. 026) 0. 567* (0. 035) -0. 118* (0. 026) No Yes Log Lagged Weights 0. 986* 0. 982* (0. 001) Relative Returns 0. 622* 0. 647* (0. 051) (0. 057) Country Crisis Fund Fixed Effects No Yes Date Fixed Effects No Yes Fund-Date Fixed No Yes Yes Effects Country of Destiny. No No Yes Fund Fixed Effects Log Lagged Weights=Relative Returns 0. 000* 0. 446 0. 000* No. of Observations 458, 458 458, 458 62, 949 0. 000* 26, 018 *=1%, †=5%, ~=10%

IV. Behavior of Managers: Country Weights (Bonds) B. Bond Funds Log Country Weights Monthly IV. Behavior of Managers: Country Weights (Bonds) B. Bond Funds Log Country Weights Monthly Semi Annual 0. 970* 0. 868* 0. 866* 0. 448* (0. 003) (0. 008) (0. 009) (0. 037) 0. 638* 0. 219* 0. 608* 0. 611* 0. 296* (0. 079) (0. 084) (0. 073) (0. 101) -0. 016 -0. 017 (0. 011) (0. 050) No No No Yes No Yes Yes Log Lagged Weights 0. 974* 0. 969* (0. 002) (0. 003) Relative Returns 0. 237* 0. 238* (0. 091) Country Crisis Fund Fixed Effects No Yes Date Fixed Effects No Yes Fund-Date Fixed Effects No Country of Destiny. No No Yes Fund Fixed Effects Log Lagged Weights=Relative 0. 000* Returns No. of Observations 39, 183 39, 183 Yes 0. 127 5, 035 Annual 0. 102~ (0. 059) 0. 310* (0. 100) -0. 026 (0. 084) No Yes 0. 023† 1, 959 *=1%, †=5%, ~=10% Relative flows less pro-cyclical than in equity: contagion, precautionary savings?

IV. Behavior of Managers: Cash Weights A. Equity Funds Log Cash Weights Variables Log IV. Behavior of Managers: Cash Weights A. Equity Funds Log Cash Weights Variables Log Lagged Weights Monthly Semi Annual 0. 587* 0. 389* 0. 360* 0. 377* 0. 112* (0. 006) (0. 008) (0. 009) (0. 024) 0. 729* 0. 700* 0. 169~ 0. 494* 0. 188* (0. 083) (0. 102) (0. 088) (0. 099) (0. 071) 0. 096~ 0. 116 (0. 158) Global Crisis (0. 051) 0. 158* (0. 049) Origin Returns (0. 018) -0. 168 Fund Fixed Effects No Yes (0. 116) Yes (0. 097) Yes Time Fixed Effects No Yes No No 0. 087~ 0. 002* 0. 029† 0. 237 0. 288 Relative Returns (-Fund return) Country Crisis Log Lagged Weights=Relative Returns Counter-cyclical cash positions 0. 116† -0. 437* -0. 083 (0. 050) -0. 181 (0. 138) 0. 498~ (0. 284) 0. 111 (0. 101) -0. 034 (0. 119) Yes No 0. 479 *=1%, †=5%, ~=10%

IV. Behavior of Managers: Cash Weights (Bonds) B. Bond Funds Log Cash Weights Variables IV. Behavior of Managers: Cash Weights (Bonds) B. Bond Funds Log Cash Weights Variables Log Lagged Weights Relative Returns Country Crisis Global Crisis Origin Returns Fund Fixed Effects Time Fixed Effects Log Lagged Weights=Relative Returns Monthly Semi Annual 0. 654* 0. 449* 0. 446* 0. 433* (0. 022) (0. 029) (0. 030) -0. 459~ -0. 422 -0. 682 -0. 381 (0. 264) (0. 303) (0. 456) (0. 298) -0. 537* (0. 172) -0. 028 (0. 047) 0. 261 (0. 520) No Yes Yes No No Yes No 0. 000 * 0. 004* 0. 015 † 0. 007* 0. 119 (0. 078) 0. 166 (0. 257) -1. 175~ (0. 670) -0. 039 (0. 138) 0. 991 (0. 949) Yes No 0. 867 -0. 380† (0. 176) 0. 510~ (0. 295) -1. 923~ (1. 057) 0. 371~ (0. 186) -0. 362 (0. 930) Yes No 0. 010 * *=1%, †=5%, ~=10% Pro-cyclical cash positions: precautionary savings? (levels also larger)

Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Reallocations IV. Behavior of Investors and Managers V. Gross and Net Country Flows VI. Conclusions

V. Gross and Net Country Capital Flows: Two Measures § Gross Flows (includes valuation V. Gross and Net Country Capital Flows: Two Measures § Gross Flows (includes valuation effects) § Net Flows

V. Net Flows All Countries Type Active Passive Frequenc y Monthly Semi. Annual Shares V. Net Flows All Countries Type Active Passive Frequenc y Monthly Semi. Annual Shares (% of Country Growth Rate) Return-Adjusted Growth Rate Injections of Weights Variance Decomposition (% of Variance of Country Growth Rate) Return-Adjusted Growth Rate Injections of Weights 88. 4% 11. 6% 84. 8% 15. 2% 87. 4% 15. 0% 12. 6% 85. 0% 86. 8% 30. 9% 13. 2% 69. 1% 88. 4% 11. 6% 84. 8% 15. 2% 83. 3% 16. 7% 78. 9% 21. 1% 80. 6% 19. 4% 73. 0% 27. 0% Manager’s behavior explains most of MF net capital flows to countries Larger for active funds

V. Gross and Net Country Flows: Quantitative Effects § 10% decline in lagged fund V. Gross and Net Country Flows: Quantitative Effects § 10% decline in lagged fund returns reduces injections in 1 pp § If all funds investing in a country experience such decline, gross flows will decline in 1 pp § This is close to the median gross flow across countries (2%) § 10% decline in country of origin returns reduces injections in 2 pp § 10% decline in relative returns (holding fund returns constant) induces a similar decline in gross flows § A country crisis leads to a 2% decline in gross flows § 10% decline in relative returns yields a 1 pp decline in relative flows § Similar to the unweighted average growth in net flows in the sample (-1. 5%) • If this is accompanied by a low fund performance or low returns in the country of origin, that can induce large redemptions (4 pp decline)

V. Gross and Net Country Flows: Quantitative Effects § For a shock to injections V. Gross and Net Country Flows: Quantitative Effects § For a shock to injections to have no effect on a country’s net flows we need relative flows to compensate in the same amount § Only countries that are doing relatively well, would not be seriously affected by shocks to the injections by underlying investors § Even in this case, contagion may be an important source of capital flows

Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Presentation I. Motivation II. Data and Summary Statistics III. Shocks to Managers and Portfolio Reallocations IV. Behavior of Investors and Managers V. Gross and Net Country Flows VI. Conclusions

VI. Conclusions: Main Results § MF assets fluctuate substantially over time, pro-cyclically § Particularly VI. Conclusions: Main Results § MF assets fluctuate substantially over time, pro-cyclically § Particularly pronounced effects during crises § Large reallocations during global crisis, consistent with retrenchment § Both investors and managers behind these movements, changing their investments substantially over time § … and shaping fluctuations in capital flows § Neither managers nor investors exploit potential arbitrage opportunities by being contrarian during crises § No stabilizing role: amplify crises & transmit shocks x countries § Important policy lesson: Runs even among equity-type investors

VI. Conclusions: Main Results § Not the case that bad shocks at home country VI. Conclusions: Main Results § Not the case that bad shocks at home country propel more investments abroad, to the contrary § Underlying investors do not act either as deep-pocket international investors buying assets abroad at fire sale prices § Their behavior exerts pressure on managers, who need to react to these shocks § Evidence not consistent with constant country weights, which change substantially over time § Managers move away from countries experiencing crises § Cash positions actively used, differently for equity and bonds

Thank you! Thank you!