Institutional Investors: From Myth to Reality

Transcription

1 Institutional Investors: From Myth to Reality Sergio Schmukler Development Research Group Policy Research Talk June 1, 2015

2 Background Work de la Torre, Ize, and Schmukler (2011). Financial Development in Latin America and the Caribbean: The Road Ahead, World Bank. Didier, Rigobon, and Schmukler (2013). Unexploited Gains from International Diversification: Patterns of Portfolio Holdings around the World. Review of Economics and Statistics. Raddatz and Schmukler (2013). Deconstructing Herding: Evidence from Pension Fund Investment Behavior. Journal of Financial Services Research. Raddatz and Schmukler (2012). On the International Transmission of Shocks: Micro- Evidence from Mutual Fund Portfolios. Journal of International Economics. Opazo, Raddatz, and Schmukler (2015). Institutional Investors and Long-term Investment: Evidence from Chile. World Bank Economic Review. Raddatz, Schmukler, and Williams (2015). International Asset Allocations and Capital Flows: The Benchmark Effect. World Bank Policy Research Working Paper No and HKIMR Working Paper No.04/2015. GFDR (2015) on Long-term Finance.

3 Introduction: Some Myths Large institutional investors expected to play crucial role, thus they received significant push Manage long-term retirement (and voluntary) savings Invest in many companies, including SMEs, and countries Diversify risk and foster access to finance Informed investors, able to make independent decisions Invest long term, including bonds and infrastructure projects Follow fundamentals Take advantage of arbitrage opportunities and provide liquidity Absorb shocks, particularly equity investors Help stabilize and develop the financial system

4 Introduction: Some Realities Big, but far away from model of capital markets as envisioned Invest differently than expected, even counter-intuitively Institutional investors invest in few companies and few countries Constraints not on lack of available funds: domestic/foreign savers Many assets available for investment not purchased by investors They hold large resources/investment in few large, liquid assets Institutional investors shy away from risk, including good ones Forego higher risk-adjusted returns Incentives for asset managers seem to play an important role Delegated portfolios: trade-off between monitoring & risk taking

5 Organization of the Evidence Hard to have a unified framework to analyze the evidence Findings from many different sources and papers, using data from Chile, the U.S., and world financial centers Findings on different aspects of institutional investors behavior, in particular their asset allocation Emphasis on regulated investors (mutual funds & pension funds), for which data could and can be collected Relative to banks and households, we can observe their portfolios, goals, benchmarks, and injections/redemptions Different findings point to similar factors, offer food for thought What to expect of institutional investors Public policy discussion going forward

6 Evidence on Institutional Investors Overview Size of institutional investors Pension funds in Chile Trading and herding Long-term investors? International evidence Diversification Pro-cyclicality Benchmark effect

7 Evidence on Institutional Investors Overview Size of institutional investors Pension funds in Chile Trading and herding Long-term investors? International evidence Diversification Pro-cyclicality Benchmark effect

8 Size of Financial System, % of GDP Financial Markets Size 120% Size of Financial System: Developed Countries Median Country 117% 107% 100% 80% 81% 84% 75% 84% 64% 60% 40% 35% 27% 31% 38% 41% 20% 0% Bank Claims on Private Sector Equity Market Capitalization Bond Market Capitalization Source: Didier, Levine, and Schmukler (2014).

9 Size of Financial System, % of GDP Financial Markets Size 100% Size of Financial System: Emerging Countries Median Country 90% 80% 70% 60% 59% 50% 40% 36% 37% 30% 28% 30% 25% 27% 20% 10% 0% 17% 14% 9% 5% 2% Bank Claims on Private Sector Equity Market Capitalization Bond Market Capitalization Source: Didier, Levine, and Schmukler (2014).

10 Non-bank Assets, % of GDP Non-bank Assets, Trillions of USD Growing Size of Institutional Investors Assets under Management by Institutional Investors 180% 160% 140% 120% 100% 80% 60% 40% 20% % Pension Funds Insurance Companies Investment Funds Assets, Total (RHS) Source: OECD. Only OECD countries included.

11 Total Assets, Trillions of USD Growing Size of Institutional Investors Institutional Investors vs Banks Non-bank Institutional Investors' Assets Banks' Assets Source: OECD. Only OECD countries included. Given data constraints, the figure does not include the following OECD countries: Czech Republic, Greece, Hungary, Portugal, Slovenia, Turkey, and United Kingdom.

12 Total Assets, % of GDP Growing Size of Institutional Investors Institutional Investor vs Bank, Assets 300% 250% 200% 254% 252% 182% 200% 219% 150% 100% 97% 95% 92% 92% 76% 117% 113% 100% 93% 80% 50% 0% Banks Non-banks Banks Non-banks Banks Non-banks Chile. Germany. United States Source: OECD.

13 Evidence on Institutional Investors Overview Size of institutional investors Pension funds in Chile Trading and herding Long-term investors? International evidence Diversification Pro-cyclicality Benchmark effect

14 Is Chile Different? Yes, but for the good reasons Innovative in macro and institutional policy, plus development of institutional investors benchmark case Has long history, rich data, and good collaboration with the Bank Can compare different institutional investors within same framework No, because many countries have followed it and patterns present several similarities Chile has been a model for many countries in pension fund reform Regulations have improved and cannot be much different in other countries When managers need monitoring, incentives play similar role Defined contribution systems are expanding, similar to Chile

15 Defined Contribution Pension Funds Important Share of Defined Contribution Assets, by Country Chile Czech Republic Estonia France Greece Hungary Poland Slovak Republic Slovenia Denmark Italy Australia Mexico New Zealand Iceland Spain United States Turkey Israel Korea Luxembourg Portugal Canada Finland Germany Switzerland Defined Benefit / Hybrid-Mixed Defined Contribution 0% 20% 40% 60% 80% 100% Share of Total Assets Source: OECD. Selected OECD countries in 2013.

16 Ratio Pension Funds Trade Infrequently Fixed-income Instruments Bought Initially and Held Until Expiration Corporate Bonds Financial Institution Bonds Government Bonds Mortage Bonds Ratio of Units at First Purchase to Maximum Units in Portfolio Ratio of Units at Expiration to Maximum Units in Portfolio Note: Data from Source: Raddatz and Schmukler (2013).

17 When They Trade, They Do It Similarly: Herding Herding within Fund Types Across PFAs, by Fund Type Herding Statistic Fund A Fund B Fund C Fund D Fund E (1) (2) (3) (4) (5) All Asset Classes 5.87 *** 3.54 *** 7.99 *** 5.65 *** 4.67 *** (0.92) (0.65) (0.49) (0.66) (0.84) Domestic Assets Corporate Bonds *** *** *** *** *** (1.93) (0.85) (0.08) (0.88) (1.06) Financial-Institution Bonds 6.63 *** *** *** 9.49 *** *** (2.61) (1.29) (1.21) (1.25) (1.70) Government Bonds *** 2.96 *** 4.94 *** 2.08 *** (1.72) (0.84) (0.44) (0.67) (0.80) Mortgage Bonds 5.02 *** 2.89 *** 1.24 *** 2.52 *** 3.26 *** (0.85) (0.17) (0.08) (0.14) (0.32) Equity 6.32 *** 0.69 * *** 6.68 *** - (0.43) (0.45) (0.60) (0.64) - Note: Data from The percentage of assets traded is calculated on a monthly basis. Source: Raddatz and Schmukler (2013).

18 Portfolio Share Along with MFs, They Tend to Invest Short Term Maturity Structure of Chilean Domestic Mutual Funds and PFAs vs. Insurance Companies 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Chilean Domestic Mutual Funds Chilean PFAs Chilean Insurance Companies Years to Maturity Note: This figure compares the maturity structure of Chilean insurance companies to that of Chilean domestic mutual funds and PFAs. Only medium- and longterm bond mutual funds are taken into account. Sample period: Source: Opazo, Raddatz, and Schmukler (2015).

19 Portfolio Share Along with MFs, They Tend to Invest Short Term Maturity Structure of Chilean Domestic Mutual Funds and PFAs vs. Insurance Companies 45% 40% 35% 30% Avg. Maturity Insurance Companies 9.77 Domestic Mutual Funds 3.97 Pension Funds % 20% 15% 10% 5% 0% <1y 1-3y 3-5y 5-7y 7-10y 10-15y 15-20y 20-30y Years to Maturity Chilean Insurance Companies Chilean Domestic Mutual Funds Chilean PFAs Note: Only medium- and long-term bond mutual funds are taken into account. Sample period: Source: Opazo, Raddatz, and Schmukler (2015).

20 Cumulative Probability Pension Funds Not Exposed to Large Net Outflows Net Inflows to Chilean MFs, PFAs, and US MFs 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5% Net Inflows as a Fraction of Fixed-term Assets US Multi-Sector Mutual Funds Chilean Domestic Mutual Funds Chilean PFAs Note: Sample period: Source: Opazo, Raddatz, and Schmukler (2015).

21 Insurance Companies Bid More for Longer Bonds Bids by Pension Funds and Insurance Companies in Government Bond Auctions Time to Maturity (Years) Ratio between Insurance Companies and Pension Funds (i) Indexed Pesos Ratio between Shares Requested (ii) Indexed Pesos, Pesos, and US Dollars, Controlling by Currency Coef. Std. Error Coef. Std. Error (0.082) (0.145) (0.076) (0.115) (0.098) (0.044) (0.044) (0.113) (0.112) (1.701) (1.701) No. of Observations Source: Opazo, Raddatz, and Schmukler (2015).

22 Annualized Return Sharpe Ratio Even When Investing Long Term Pays Off 14% Indices of Chilean Government Inflation-Indexed Bonds Return Sharpe Ratio % 10% 8% % 4% 2% % Years to Maturity Years to Maturity Note: Sample period: Source: Opazo, Raddatz, and Schmukler (2015).

23 % of Total Portfolio Portfolios Tilted toward Deposits and Public Bonds Composition of Pension Fund Investments in Latin America Govt. Securities Fin. Inst. Sec/Deposits Private Bonds Foreign Securities Equities Mutual Funds Other Investments 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2% 2% 3% 3% 2% 3% 3% 5% 9% 1% 2% 6% 2% 11% 8% 12% 3% 12% 15% 7% 17% 11% 6% 14% 33% 2% 17% 20% 5% 10% 9% 9% 2% 6% 32% 3% 11% 6% 17% 9% 15% 32% 8% 88% 73% 64% 59% 29% 29% 49% 47% 30% 13% 14% 6% 2% 36% 11% 12% 11% 21% 1% 3% 2% 2% 34% 36% 61% 59% Argentina Chile Colombia Mexico Peru Uruguay Source: OECD, ABRAPP, AIOSFP, FIAP, and local sources.

24 % of Total Assets Mutual Funds Also in Deposits and Public Bonds Mutual Funds - Portfolio Holdings Chile Deposits Private Bonds Domestic Equity Foreign Equity Public Bonds 100% 90% 80% 70% 6% 14% 8% 2% 4% 9% 17% 13% 60% 50% 40% 30% 63% 63% 20% 10% 0% Source: IMF s IFS, FGV-Rio, Conasev, Superfinanciera, Andimia, and Banxico.

25 Evidence on Institutional Investors Overview Size of institutional investors Pension funds in Chile Trading and herding Long-term investors? International evidence Diversification Pro-cyclicality Benchmark effect

26 Median Number of Stock Holdings Similar Number of Holdings Across Fund Types Median Number of Stocks Held by Mutual Funds World Funds World Funds - Excluding U.S. Holdings Foreign Funds Emerging Market Funds Regional Funds Source: Didier, Rigobon, and Schmukler (2013).

27 Median Number of Stock Holdings Similar Number of Holdings Across Fund Types Median Number of Stocks Held by Mutual Funds Asia Funds Europe Funds Latin America Funds Country Funds Source: Didier, Rigobon, and Schmukler (2013).

28 Changes Within Families Number of Countries Fund Type Asia Developed Europe Latin America Regional Funds Median Number of Countries Drop in the Number of Countries in Each Region by Fund Type (In Percent, Relative to Regional Funds) Emerging Market Funds -10% - -17% Foreign Funds -30% 0% -72% World Funds -36% -14% -75% Source: Didier, Rigobon, and Schmukler (2013).

29 Nigeria Saudi Arabia Romania Lithuania Latvia Slovak Republic Bangladesh Bulgaria Tunisia Iceland Oman Jordan Cyprus Pakistan Egypt India Croatia Uruguay Slovenia Ecuador Sri Lanka Peru Colombia Kazakhstan Estonia Zimbabwe Chile Czech Republic Spain Israel Panama Venezuela Morocco Kenya Botswana South Africa Lebanon Brazil Poland Canada Philippines Russia All China* Australia Indonesia Mauritius Turkey Thailand Malaysia Greece South Korea Portugal Ghana Argentina Germany Hungary Mexico Norway France United Kingdom Austria Singapore Denmark Belgium New Zealand Finland Switzerland Sweden Japan Italy Ireland Netherlands Number of Mutual Fund Holdings/Listed Stocks Mutual Funds Hold Relatively Few Stocks 100% 90% Mutual Fund Holdings as a Proportion of the Total Number of Listed Stocks 80% 70% 60% 50% 40% 30% 20% 10% 0% Note: The sample period is Source: Didier, Rigobon, and Schmukler (2013).

30 Entropy Having Managers in Common Increases Entropy Entropy Measure by Number of Common Managers All funds No Common Manager At least 1 Common Manager More than 3 Common Managers Source: Didier, Rigobon, and Schmukler (2013).

31 Family Effects Are Relevant Number of Stock Holdings (1) (2) (3) (4) (5) Adjusted R-squared Independent Variables Year Dummies Yes No Yes No Yes Fund Type Dummies No No No Yes Yes Family Dummies No Yes Yes Yes Yes No. of Observations 6,394 6,394 6,394 6,394 6,394 % of Net Assets in Top Ten Holdings (1) (2) (3) (4) (5) Adjusted R-squared Independent Variables Year Dummies Yes No Yes No Yes Fund Type Dummies No No No Yes Yes Family Dummies No Yes Yes Yes Yes No. of Observations 6,379 6,379 6,379 6,379 6,379 Source: Didier, Rigobon, and Schmukler (2013).

32 Holding Patterns Are Costly Type of Global Funds Global Funds Average Returns (Per Year) Simulated Global Funds Minimizing the Variance Average Difference in Accumulated Returns Standard Deviation of Returns Global Funds Simulated Global Funds Number of Comparisons Daily Data World Funds 6.22% 11.01% 4.85% 0.87% 0.78% 63 Foreign Funds 6.03% 9.95% 4.03% 0.97% 0.89% 77 Pools of World or Foreign Funds 10.53% 15.23% 4.55% 0.86% 0.80% 25 Total 6.78% 11.14% 4.42% 0.92% 0.84% 165 Weekly Data World Funds 6.28% 11.33% 5.08% 2.05% 1.92% 63 Foreign Funds 6.04% 9.70% 3.74% 2.25% 2.13% 77 Pools of World or Foreign Funds 10.54% 15.16% 4.44% 1.99% 1.90% 25 Total 6.80% 11.13% 4.36% 2.14% 2.01% 165 Source: Didier, Rigobon, and Schmukler (2013).

33 Jan. 96 Jul. 96 Jan. 97 Jul. 97 Jan. 98 Jul. 98 Jan. 99 Jul. 99 Jan. 00 Jul. 00 Jun. 01 Jun. 02 Jun. 03 Jun. 04 Jun. 05 Jun. 06 Jun. 07 Jun. 08 Jun. 09 Jun. 10 Total Assets, Billions of USD Total Assets, Billions of USD Volatile Total Assets in Global Equity Funds Source: Raddatz and Schmukler (2012).

34 Jan. 07 May. 07 Sep. 07 Jan. 08 May. 08 Sep. 08 Jan. 09 May. 09 Sep. 09 Portfolio Share Jan. 07 May. 07 Sep. 07 Jan. 08 May. 08 Sep. 08 Jan. 09 May. 09 Sep. 09 Jan. 07 May. 07 Sep. 07 Jan. 08 May. 08 Sep. 08 Jan. 09 May. 09 Sep. 09 Portfolio Share Portfolio Share Volatile Portfolios Global Equity Funds 56% 54% 52% 50% 48% 46% 44% 42% 40% Northern Rock Developed Europe Bear Stearns Lehman Brothers AIG 22% 21% 20% 19% 18% 17% 16% North America 15% 14% 13% 12% 11% 10% 9% 8% 7% Emerging Countries Average portfolio shares Source: Raddatz and Schmukler (2012).

35 Jan. 07 May. 07 Sep. 07 Jan. 08 May. 08 Sep. 08 Jan. 09 May. 09 Sep. 09 Portfolio Share Jan. 07 May. 07 Sep. 07 Jan. 08 May. 08 Sep. 08 Jan. 09 May. 09 Sep. 09 Jan. 07 May. 07 Sep. 07 Jan. 08 May. 08 Sep. 08 Jan. 09 May. 09 Sep. 09 Portfolio Share Portfolio Share Volatile Portfolios Global Bond Funds 60% Developed Europe 30% North America 50% 25% 40% 20% 30% 15% 20% 10% Northern Rock Bear Stearns Lehman Brothers AIG 10% 5% 0% 0% 30% Emerging Countries 25% 20% Average portfolio shares 15% 10% Source: Raddatz and Schmukler (2012).

36 Share of TNAs Growing Number of Funds Follow Benchmarks Equity Funds 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% % Explicit Indexing Closet Indexing Mildly Active Truly Active Source: Raddatz, Schmukler, and Williams (2015).

37 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Country Weight Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Country Weight Motivation: Israel upgrade from EM to DM 5% 4% 3% 2% 1% % Global Emerging Funds and MSCI Emerging Markets Index Announcement Date Effective Date Explicit Indexing Funds 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% Global Funds and MSCI World Index Truly Active Funds 5% Global Emerging Funds and MSCI Emerging Markets Index 0.6% Global Funds and MSCI World Index 4% 0.5% 3% 2% 0.4% 0.3% 0.2% 1% 0.1% % 0.0% Average Mutual Fund Weight Benchmark Weight Source: Raddatz, Schmukler, and Williams (2015).

38 Benchmarks Help with Identification Benchmarks important beyond country-time (fundamentals) and industry-time effects Changes in benchmark weights relate to relative returns w B B ct = w ct 1 (R ct /R B t ) Buy and Hold B + E ct "Exogenous" Weights can move in opposite directions in different benchmarks (same country, same time) Exogenous shocks that shed light on identification Source: Raddatz and Schmukler (2012) Source: Raddatz, Schmukler, and Williams (2015).

39 Mutual Fund Weights vs. Benchmark Weights Explicit Indexing w ict w ct vs. w B B ict w ct Closet Indexing Mildly Active Truly Active Source: Raddatz, Schmukler, and Williams (2015).

40 Effects on Capital Flows Benchmark weights and capital flows linked through identity F ict = Direct benchmark effect Sensitivity effect Amplification effect Contagion effect w ict F it Net Inflows BH + A it w ict w ict Reallocation Source: Raddatz and Schmukler (2012) Source: Raddatz, Schmukler, and Williams (2015).

41 Capital Flows, Millions of USD Direct Benchmark Effect: Israel s Upgrade (5/2010) Capital Flows in Levels: All Types of Funds ,000-1,500-2,000-2,073-1,913-2,500 Emerging Markets Funds Developed Markets Funds Total Country Flows Source: Raddatz and Schmukler (2012) Source: Raddatz, Schmukler, and Williams (2015).

42 BoP, Millions of USD Direct Benchmark Effect in Israel s BoP 5,000 4,000 Announcement date 3,000 2,000 1, ,000-2,000-3,000 Effective date Portfolio Equity Inflows Portfolio Debt Inflows Source: Raddatz and Schmukler (2012) Source: Raddatz, Schmukler, and Williams (2015).

43 Feb 2010 Apr 2010 Jun 2010 Aug 2010 Oct 2010 Dec 2010 Feb 2011 Apr 2011 Jun 2011 Aug 2011 Oct 2011 Dec 2011 Feb 2012 Apr 2012 Jun 2012 Aug 2012 Oct 2012 Dec 2012 Feb 2013 Apr 2013 Jun 2013 Aug 2013 Oct 2013 Dec 2013 Feb 2014 Apr 2014 Jun 2014 Aug 2014 Oct 2014 Share Held by Foreign Investors Purchases by Foreign Investors, Millions of USD Direct Benchmark Effect in Colombian TES bonds Participation of Foreigners in TES bonds 16% 2,500 14% 12% 10% J.P. Morgan weight increase 2,000 1,500 8% 1,000 6% 4% 2% % -500 Total Purchases of TES by Foreigners (RHS) Percentage Holdings of TES by Foreigners Source: Raddatz, Schmukler, and Williams (2015).

44 Flows, Millions of USD Benchmark Weight Amplification and Sensitivity Effect MSCI Emerging Markets Index ETF Pre-Crisis Period 7% % 8% 7% 6% 5% 1,800 1, Global Financial Crisis and Post-Crisis Period 17% 6% 20% 15% 10% 5% 80 4% 0 % China Russia 3% 2% 1% % ,200-1,800-1,352.3 China Russia -5% -10% -15% -20% Country Flows (LHS) Benchmark Weight (RHS) Source: Raddatz and Schmukler (2012) Source: Raddatz, Schmukler, and Williams (2015). The pre-crisis period is May 2003 May The crisis and post-crisis period are Sep Sep

45 June 2, 2009 June 4, 2009 June 8, 2009 June 10, 2009 June 12, 2009 June 16, 2009 June 18, 2009 June 22, 2009 June 24, 2009 June 26, 2009 June 30, 2009 May 10, 2010 May 12, 2010 May 14, 2010 May 18, 2010 May 20, 2010 May 24, 2010 May 26, 2010 May 28, 2010 June 1, 2010 June 3, 2010 June 7, 2010 June 9, 2010 June 11, 2010 June 15, 2010 June 17, 2010 June 21, 2010 June 23, 2010 June 25, 2010 Index (Jun 16, 2009=100) Index (May 14, 2010 =100) Price Effects: Israel's Upgrade and Stock Returns Stock Market Prices of Israeli Firms Around Israel's Upgrade Announcement date Two weeks prior effective date Effective date Source: Raddatz and Schmukler (2012) Note: Index returns is a market capitalization price index of firms covered by MSCI. Non Index returns is a market capitalization price index of firms not covered by MSCI. Source: Raddatz, Schmukler, and Williams (2015).

46 Jan 01, 2009 Jan 21, 2009 Feb 10, 2009 Mar 02, 2009 Mar 20, 2009 Apr 09, 2009 Apr 29, 2009 May 19, 2009 Jun 08, 2009 Jun 26, 2009 ADR Premium Price Effects: Direct Benchmark Effect Argentina Argentina's Equity Market Around MSCI's Downgrade 40% 35% 30% 25% 20% Announcement date Two weeks prior effective date 15% 10% 5% Effective date 0% -5% -10% Source: Raddatz and Schmukler (2012) Note: The figure illustrates the log difference between stock price of firms entering Argentina's MSCI index (ADRs) and the stock price of firms going out of the index. Source: Raddatz, Schmukler, and Williams (2015).

47 Jan 16, 2014 Jan 30, 2014 Feb 13, 2014 Feb 27, 2014 Mar 13, 2014 Mar 27, 2014 Apr 10, 2014 Apr 24, 2014 May 08, 2014 May 22, 2014 Jun 05, 2014 Jun 19, 2014 Jul 03, 2014 Jul 17, 2014 Jul 31, 2014 Aug 14, 2014 Aug 28, 2014 Sep 11, 2014 Sep 25, 2014 Oct 09, 2014 Index (Mar 19, 2014=100) Price Effects: Direct Benchmark Effect Colombia Colombia's Sovereign Debt Market Around J.P. Morgan's Upgrade Announcement date Completion date Index Returns Non Index Returns Source: Raddatz and Schmukler (2012) Note: Index returns is a local currency debt index (in USD) containing all bonds entering the benchmark and non index returns is a local currency debt index (in USD) from bonds not affected by the benchmark change. Source: Raddatz, Schmukler, and Williams (2015).

48 Price Effects: Contagion in Frontier Markets Impact on Frontier Countries Due to the MSCI Upgrade of Qatar and UAE Announcement Date MSCI Frontier Markets Index (exc. Qatar and UAE) MSCI Emerging Markets Index MSCI World Index Source: Raddatz and Schmukler (2012) Source: Raddatz, Schmukler, and Williams (2015).

49 March 13, 2014 March 14, 2014 March 17, 2014 March 18, 2014 March 19, 2014 March 20, 2014 March 21, 2014 March 24, 2014 March 25, 2014 March 26, 2014 March 27, 2014 March 28, 2014 March 31, 2014 April 1, 2014 April 2, 2014 April 3, 2014 April 4, 2014 April 7, 2014 April 8, 2014 April 9, 2014 April 10, 2014 April 11, 2014 April 14, 2014 April 15, 2014 April 16, 2014 April 17, 2014 Index (Mar 31, 2014=100) Price Effects: Contagion in Frontier Markets Impact on Frontier Countries Due to the MSCI Upgrade of Qatar and UAE Announcement date Index Returns Non Index Returns Source: Raddatz and Schmukler (2012) Source: Raddatz, Schmukler, and Williams (2015).

50 May 19, 2014 May 21, 2014 May 23, 2014 May 27, 2014 May 29, 2014 June 2, 2014 June 4, 2014 June 6, 2014 June 10, 2014 June 12, 2014 June 16, 2014 June 18, 2014 June 20, 2014 June 24, 2014 June 26, 2014 June 30, 2014 July 2, 2014 July 4, 2014 July 8, 2014 July 10, 2014 July 14, 2014 July 16, 2014 July 18, 2014 July 22, 2014 July 24, 2014 July 28, 2014 July 30, 2014 August 1, 2014 August 5, 2014 August 7, 2014 Index (May 28, 2014=100) Price Effects: Contagion in Frontier Markets Impact on Frontier Countries Due to the MSCI Upgrade of Qatar and UAE Second effective date First effective date Third effective date 96 Index Returns Non Index Returns Source: Raddatz and Schmukler (2012) Source: Raddatz, Schmukler, and Williams (2015).

51 Concluding Remarks: Bottom Line Constraints not on the supply side of funds Constraints not on the availability of investable assets Constraints likely not on specific regulatory issues These get much attention at country level, but this is a cross-country issue Financial intermediation process more difficult than thought Governments and large firms receive most of the financing Incentives and organizational issues seem to play crucial role and restrict (good) risk taking options Might not yield socially optimal outcome Financial intermediaries brain of the economy but work differently than expected

52 Some General Policy Challenges Generate healthy competition among financial intermediaries and market discipline, consistent with intended goals Reduce fees and foster benchmarking without boosting shorttermism, herding, coordination effects, pro-cyclicality, volatility Foster long-term risk taking while being able to monitor managers Generate contrarian behavior and long-term arbitrage opportunities without backlash due to negative outcomes Take advantage of useful international diversification Think of alternative ways of managing retirement assets How will the change come about?

53 Pension and Mutual Funds: Incentives Regulators in tight spot Regulatory incentives to minimize risk relative to benchmark Having similar portfolios minimizes that risk (herding type of behavior) Difficult to come up with very different regulatory structure Why is the industry tilted toward low (idiosyncratic) risk with short maturity, as one example of low risk taking? Some factors have pushed equilibrium to short term, kept it there Equilibria can be quite persistent, displaying hysteresis Can long-term benchmarks shift portfolios to the long term?

54 Pension and Mutual Funds: Incentives Investor side Market discipline Outflows (or the threat of) / redemptions Based on short-term returns Outflows potentially more important for MFs systemic Pay structure (tracking error) Tracking error investment model (tracking the mean)? Asset return volatility Incentives to produce stable returns in the short run Link to liability structure Loss aversion by underlying investors? Cost of information acquisition? Focus on low information intensity assets

55 Features Not Country Specific Patterns not exclusive of developing countries Unexpected patterns even in U.S. and develop countries Invest in few stocks Do not share information within companies Are pro-cyclical even when investing in equities and even when shocks have already hit them Are subject to significant redemptions from investors Follow benchmarks and behave passively, which can add to procyclicality through coordination effects Organizational factors seem key to understand behavior However and unfortunately, not clear alternative model

56 Directions for Future Work Benchmarks What determines the intensive and extensive margins? Effects on cost of capital to corporations and corporate financing Effects on domestic institutional investors Active management What determines deviations from the benchmarks? Are there arbitrage/investment opportunities? Asset managers and financial stability (BIS, FSB, IMF) How do funds manage their liquidity? To what extent do asset managers generate pro-cyclicality in capital flows and investments?

57 Directions for Future Work Prospects for financial development Experiences with long-term and illiquid financing Infrastructure finance and SME finance by institutional investors? Different models of institutional investors? Different results? Domestic investors vs. foreign investors in long-term finance Others institutional investors (SWF, PE, VC, HF) Government role Role of public sector in managing/regulating retirement savings Scope for new regulation and tradeoffs Institutional investors and big data

58 Thank you!