The coming wave: Where emerging market investors will put their money

George Karolyi, David Ng, Eswar Prasad

12 December 2015



Emerging market economies now account for a rising share of world GDP and a substantial fraction of world growth. These economies are also playing an increasingly prominent role in global financial flows. With their strong growth prospects, they have attracted foreign investors in search of higher returns, especially at a time of very low interest rates in the advanced economies (Magud et al. 2014, Cerutti et al. 2015). Now an even more striking phenomenon is gradually gathering momentum – the outflow of financial capital from these economies. Understanding the volumes and patterns of these outflows, and analysing their determinants, is of considerable interest in order to shed light on how the geography of international capital flows is likely to change as emerging markets mature and become more integrated into global financial markets.

Why do we expect a new wave of portfolio outflows from emerging markets? Rising domestic incomes have increased private sector demand for foreign investments in this economies, both for diversification purposes and for the acquisition of higher-quality assets. Institutional investors such as mutual funds, pension funds, and insurance companies are investment vehicles creating ever more avenues for portfolio diversification through outward investments. These factors, along with continued capital account liberalisation and domestic financial market development, are likely to lead to further increases in private capital outflows from emerging markets. China, for instance, has been creating a number of channels for outward portfolio investments by retail investors, mutual funds, and various institutional investors, including its sovereign wealth funds.  

Portfolio outflows from emerging markets are still relatively small, but growing rapidly. According to IMF data on external assets and liabilities, emerging markets’ share of global external portfolio equity assets rose from 5% in 2000 to 11% in 2011. Official data on international investment positions show that emerging markets’ external portfolio equity assets rose from $52 billion in 2000 to $347 billion in 2013. Inflows from emerging markets are playing an increasingly important role in external portfolio liabilities of even major developed market economies. Indeed, the share of foreign holdings of US equities accounted for by emerging market investors rose from 2% in 2002 to nearly 9% in 2014.

Our study is the first to characterise comprehensively the global allocation of foreign portfolio equity assets of emerging market investors. Part of our analysis is based on bilateral investment positions between countries, obtained from the IMF’s Coordinated Portfolio Investment Survey (CPIS). To provide an alternative perspective, we also use FactSet Ownership (formerly referred to as ‘Lionshares’), a database covering thousands of institutional investors’ holdings in different countries. Using two different datasets allows us to extend previous authors’ analysis of the portfolio allocations of developed markets, which has largely been based on the Coordinated Portfolio Investment Survey.

We study the behaviour of institutional investors in detail, given their importance in intermediating portfolio flows. Prior research on cross-border equity investment patterns of institutional investors has almost entirely focused on investments among developed markets or from developed to emerging market economies. We use the existing body of research as a point of departure but the novelty of our analysis is its focus on investments from emerging markets.

A basic theoretical benchmark is that investors in all countries, including emerging markets, should hold the same market capitalisation-weighted basket of major stock market indexes – the world portfolio. But a large body of research in international finance has documented that this benchmark is violated along two dimensions. First, home bias is a pervasive phenomenon. Second, a substantial fraction of the aggregate outward portfolio investment reveals systematic over- and under-weightings across countries – the so-called ‘foreign allocation bias’ or ‘foreign bias’ - that tend to be driven by factors such as geographic proximity, linguistic similarity, cultural ties, and other factors that reflect a ‘familiarity’ (or regional) bias.

We focus on the foreign bias as our objective is to study foreign portfolio investment patterns among emerging market investors. We specifically define the foreign allocation bias as the extent to which international portfolio allocations across destination countries deviate from their respective market-capitalisation weights in the world market portfolio. We first uncover emerging market investors’ portfolio allocations on average exhibit significantly greater overall foreign allocation biases in absolute magnitudes and higher country concentrations than those of developed market economies.

To guide our empirical analysis, we then turn to the concept of information immobility proposed by van Nieuwerburgh and Veldkamp (2009, 2010). Rather than relying on information asymmetries, which should in principle decline over time, their theoretical model recognises that investors face a choice in deciding about which assets to acquire information when there are multiple risky assets in the investment opportunity set. For instance, investors have a comparative advantage in learning about their domestic assets. Even as information about foreign markets becomes easier to obtain, the initial information endowment leads investors to exert more effort in acquiring additional information about domestic assets, magnifying their comparative advantage. Similarly, investors would prefer to invest in foreign countries where they had an initial information endowment.

We propose empirical proxies on a country level and on an institutional investor level to detect possible emerging market investors’ information endowments for a particular destination country for their outward investments. On a country level, the proxies are historical foreign direct investment and trade flows between the home and destination country for outward portfolio investments. Such historical foreign and direct investment and trade flows typically result in business contacts and investment relationships that could serve as a source of the initial information endowment.

On an institutional investor level, we propose new empirical proxies for information endowments by exploiting the granularity of the FactSet LionShares data. Many emerging market institutions are foreign subsidiaries of parent institutions headquartered abroad. Through corporate relationships between parent and subsidiary institutions, these subsidiaries may build up information endowments on their parent institutions’ home country and on ‘peer’ countries where their parent institutions have set up other foreign subsidiaries.


We find strong and robust evidence to support our formulation of the information endowment hypothesis. More importantly, information endowments show themselves to play an even bigger role in explaining the investment patterns of emerging market allocations relative to those of developed markets and to institutional investors domiciled in developed markets (for more evidence on determinants of flows into emerging markets, see Karolyi 2015). The results remain strong when we put the hypothesis to an even more rigorous test by examining the investment patterns of specific institutional investors using information endowment proxies based on the location of the parent company of emerging market institutional investors that are foreign subsidiaries (for non-indigenous institutions) and the location of other foreign subsidiaries of the parent company. Both of these proxies turn out to be important determinants of the allocation patterns of emerging market institutional investors.


The bottom line is that history – in terms of past foreign direct investments and trade flows or existing institutional arrangements – might prove to be an important determinant of emerging markets’ allocation of their international investment portfolios. This has implications for the geographical distribution of emerging markets’ portfolio investments, which are becoming a force to reckon with in international financial markets.


Cerutti, E, S Claessens and D Puy (2015), “Push Factors and Capital Flows to Emerging Markets: Why Knowing Your Lender Matters More Than Fundamentals”, IMF Working Paper 15/127, available at

Karolyi, G A (2015), Cracking the Emerging Markets Enigma, Oxford University Press, New York, NY.

Karolyi, G A, D T Ng, and E S Prasad (2015), “The Coming Wave: Where do Emerging Market Investors Put Their Money?”, NBER Working Paper No. 21661, available at

Magud, N, C M Reinhart, and E R Vesperoni (2014), “Capital Inflows, Exchange Rate Flexibility, and Credit Booms”, Review of Development Economics 18(3): 415-430, also available on VoxEU at

Van Nieuwerburgh, S and LVeldkamp (2009), “Information Immobility and the Home Bias Puzzle”, Journal of Finance 64: 1187-1215.

Van Nieuwerburgh, S and LVeldkamp (2010), “Information Acquisition and Under-diversification”, Review of Economic Studies 77(20): 779-805.



Topics:  Development Financial markets

Tags:  investment, emerging markets, emerging economies, financial markets

Professor of Finance, Samuel Curtis Johnson Graduate School of Management, Cornell University

Professor of Finance, Cornell University

Tolani Senior Professor of Trade Policy at Cornell University, Senior Fellow of the Brookings Institution and Research Associate, NBER