Elephants in Equity Markets

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Discussion by Valentina Bruno

WOW! Findings

• 5% of equity mk cap mutual funds data account for almost all of individual equity and aggregate stock market price changes
• Look through mutual funds and you’ll see the entire market

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WOW! Findings

• Stock picking is a dominant force in individual stock price movements
• Stock Picking is even more important in Emerging Markets (rebalancing across borders)

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Elephants are fast

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• Mutual funds quickly shift between assets, countries, and currencies in response to global conditions.
• They can cause rapid capital outflows during crises.
• They are not always slow-moving, long-term investors—they often adjust their portfolios quickly to chase performance.

My comments

• The role of exchange rates
• What exchange rate?
• The role of mutual funds

The role of exchange rates

• In this paper, exchange rate movements help stabilize local stock markets, except in safe-haven and pegged currency markets (USD, JPY, CHF, HKD).
• sub-component tends to be the most negative for emerging market economies and can be as negative as -48% for ZAR, -42% for MXN and -40% for BRL

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• the exchange rate appreciates when equity holdings increase, implying that local-currency equity prices need to increase by less in order to clear the equity market

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Another view of the role of exchange rates

• Foreign investors typically do not hedge their currency risk
• They are exposed to stock price and FX fluctuations (double whammy).
• Since stock prices and currencies tend to move in the same direction, this bundled risk can amplify their gains or losses.
• "Risk-Off"
• The Brazilian stock market falls by 10%.
• The BRL depreciates by 5% against the USD.
• The U.S. investor suffers a total loss of 15% in USD terms
• Calvo and Reinhart (2002), Hau and Rey (2006), Forbes and Warnock (2012), Bruno & Shin (2015)

Dollar beta (Bruno, Shim, Shin, 2022)

The broad dollar index is the priced factor rather than the bilateral exchange rate

Bad Elephant, Good Elephant?

Mutual funds are the bad elephants

Chen, Goldstein and Jiang, JFE, 2010

Strategic complementarities among mutual fund investors generate fragility in financial markets.

- the expectation that other investors will withdraw their money reduces the expected return from staying in the fund and increases the incentive for each individual investor to withdraw as well

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Bruno, Bertaut and Shin (2024) Original Sin Redux

Strategic complementarities among mutual funds in EME

- double whammy coming from exchange rate fluctuations and price changes