Geopolitical Tensions and Asset Allocation: How Do Investment Funds Distribute Their Exposures?

Do geopolitical tensions between countries influence the cross-border asset allocation of investment funds?

The answer is positive.

Using our ICRG risk metrics as a means of developing a proxy for ‘institutional quality,’ the authors of this new International Monetary Fund Working Paper estimate gravity models and find that investment funds allocate smaller shares of their portfolios to recipient countries that are geopolitically more distant to their country of origin.

They also found an investment diversion effect: a recipient country attracts additional investments when its source countries get geopolitically more distant to third-party countries.

“Geopolitical distance” is measured by the dissimilarity in countries’ voting behavior in the United Nations General Assembly.

The study also shows that countries with lower institutional quality are more vulnerable to geopolitical shifts, and geopolitical tensions can generate cross-border investment diversion, whereby a recipient country attracts additional investments when the geopolitical distance between its source countries and their financial partner countries increases.

(https://lnkd.in/e-JcvkEx)

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