Global Asset Allocation Shifts

University of Basel; University of Mannheim – Finance Area

City University London – Sir John Cass Business School

Andreas Schrimpf

Bank for International Settlements (BIS) – Monetary and Economic Department

Abstract:

We show that global asset reallocations of U.S. fund investors obey a strong factor structure, with two factors accounting for more than 90% of the overall variation. The first factor captures switches between U.S. bonds and equities. The second reflects reallocations from U.S. to international assets. Portfolio allocations respond to U.S. monetary policy, most prominently around FOMC events when institutional investors reallocate from basically all other asset classes to U.S. equities. Reallocations of both retail and institutional investors show return-chasing behavior. Institutional investors tend to reallocate toward riskier, high-yield fixed income segments, consistent with a search for yield.

Global Asset Allocation Shifts – Introduction

This paper studies global asset reallocation decisions of investors in U.S. domiciled mutual funds. Looking at a broad menu of asset classes, our goal is to provide a better understanding of fund investors’ global asset reallocations and the link to U.S. monetary policy.

A more thorough understanding of global asset allocation decisions by fund investors is warranted for a variety of reasons. In recent years, the wealth intermediated by asset managers has risen considerably (e.g. Shin, 2013; Feroli, Kashyap, Schoenholtz, and Shin, 2014).1 Strong fluctuations in international portfolio flows over the same period have raised concerns about potential contagion and amplification effects due to the behavior of fund investors and asset managers in response to shocks (e.g. Jotikasthira, Lundblad, and Ramadorai, 2012; Raddatz and Schmukler, 2012). Such movements in international portfolio flows have often been attributed to the policy actions by major central banks during the recent financial crisis. More specifically, U.S. monetary policy has been argued to have contributed to swings in international portfolio flows and to act as a global push factor (Fratzscher, Lo Duca, and Straub, 2012) for capital flows. Another line of argument is that the low interest rate environment (pre- and post-crisis) has contributed to a search for yield in fixed income markets (e.g. Rajan, 2005; Stein, 2013).

In our empirical analysis, we address these issues and tackle the following questions: (i) What are the main factors that characterize global reallocations? (ii) Given the important role of central bank policies in affecting financial markets in recent years, what is the link between monetary policy and global asset allocation shifts? (iii) Is there evidence that investors search for high returns internationally? More specifically, do investors chase past returns (consistent with momentum trading), and/or do reallocation decisions reflect a search for yield in xed income segments?

A distinguishing feature of our work is to directly study the behavior of investors via quantities (reallocation decisions). Our results are based on detailed mutual fund data from EPFR Global, from which we can infer changes in fund investors’ portfolio allocations to a variety of U.S. and foreign equity and fixed income segments. Moreover, we can distinguish between retail and institutional investors, and the data allow us to track portfolio allocations {as opposed to simple fund flows.2 This distinction is important, as shown in Curcuru, Thomas, Warnock, and Wongswan (2011) because flows are not necessarily informative about active reallocation decisions, when portfolio wealth is not constant over time. Our data are sampled at a weekly frequency, allowing us to investigate drivers of allocation shifts at a fairly high frequency. The period we study ranges from January 2006 – December 2014, and hence covers the global financial crisis, its run-up period and the aftermath.

Our first contribution is to document a striking pattern in international portfolio reallocations of fund investors: Global asset allocation shifts obey a strong factor structure, with two factors accounting for more than 90% of the overall variance of reallocations. The first factor captures around 80% of the overall variance and can be interpreted as a rotation (ROT) factor: It tracks rotation out of U.S. bonds and into U.S. equities. The second factor tracks shifts out of U.S. assets (bonds and equities) and into foreign assets. This factor captures reallocation decisions driven by international diversification motives (DIV) of fund investors.