Emerging Markets Review 6 (2005) 211 237 www.elsevier.

com/locate/econbase

Mutual fund preferences for Latin American equities surrounding financial crises
Susan Elkinawy *
Loyola Marymount University, Hilton Center for Business, One LMU Drive, MS 8385, Los Angeles, CA 90045-2659, United States Received 25 January 2005; received in revised form 28 April 2005; accepted 24 May 2005

Abstract Using data on dedicated Latin American mutual funds and nearly 1000 Latin American stocks during the Asian and Russian currency crises, I find that the effects of certain firm characteristics on mutual fund stock ownership are different than in non-crisis years. In response to crises, fund managers increase their holdings of cross-listed firms. This finding is evident among closed-end funds, suggesting features beyond liquidity influence stock ownership. Funds also reduce their holdings of firms competing with Russias main exports. These results suggest that in addition to liquidity, trade links and governance concerns are important determinants of portfolio choice during crises. D 2005 Elsevier B.V. All rights reserved.
JEL classification: G11; G15 Keywords: Mutual funds; Financial crises; Emerging markets; Foreign portfolio investment

1. Introduction The dramatic reduction of barriers to foreign investment in recent years has led to increased interest in the study of foreign investor behavior. For example, Kang and Stulz

* Tel.: +1 310 338 2345. E-mail address: selkinawy@lmu.edu. 1566-0141/$ - see front matter D 2005 Elsevier B.V. All rights reserved. doi:10.1016/j.ememar.2005.05.001

212

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

(1997) and Dahlquist and Robertsson (2001) examine the preferences of foreign investors in Japan and Sweden in order to improve understanding of the home bias phenomenon. In the 1990s, foreign investors had a particular interest in emerging markets due to the liberalization of many developing countries to foreign investment combined with increased privatization of state-owned enterprises. While the influx of foreign investment resulted in strong economic growth for emerging markets, the ease of capital mobility also left these countries vulnerable to abrupt changes in investor sentiment with subsequent turmoil in the currency and stock markets. The financial crises of the late 1990s were unlike earlier crises that were generally local or regional in nature. The turmoil that began in Asia and Russia in 1997 and 1998 resulted in cross-border contagion effects that reached markets globally, with developing regions like Latin America particularly vulnerable. Chriszt (1999) indicates that the problems in Asia and Russia affected Latin America through trade and financial markets, as Latin American stock prices plunged in 1997 and 1998. Bekaert et al. (2005) conduct formal correlation tests of idiosyncratic shocks and confirm that contagion from Asia spread to Latin America. The financial channel of contagion was most significant, since the Asian crisis led investors to treat all emerging markets as an asset class and reassess their investments in Latin America. These events have provided a new motivation for examining the actions of foreign investors. I provide evidence on foreign investor behavior surrounding the Asian and Russian crises by determining particular firm characteristics that affect the portfolio choices of U.S.-based mutual fund managers in dedicated Latin American funds. My results indicate that fund managers preferences change subsequent to a crisis originating outside of their region. This research is motivated by studies such as Kaminsky et al. (2001a) who find that dedicated Latin American funds engage in contagion trading by selling assets from one country when prices fall in another. This study complements the contagion literature on fundamental factors as well as herding and momentum trading.1 Fundamental factors include trade linkages or other macroeconomic conditions. However, as Forbes (2004) argues, these factors are typically aggregate country-level measures that ignore a good deal of within-country variation. She indicates that micro-level data like the attributes of individual firms can provide greater insight into the way financial shocks are propagated, since the effect of externally based crises on local companies can vary widely. In addition, firm characteristics yield deeper insight into the types of stocks that are subject to momentum trading and offer another dimension to portfolio choice. Although this study examines how mutual funds react to financial crises, the findings may provide a first step to better understanding the role of foreign investors in causing the transmission of crises. My sample consists of the portfolio holdings of all existing Latin American mutual funds from 1996 to 2001, twenty-six open-end and eleven closed-end funds. This time period encompasses the currency attacks in Thailand and surrounding countries in midHerding occurs when a group of investors exhibit similar buying and selling behavior toward certain stocks, while momentum trading refers to the systematic purchase and sale of stocks based on historical returns. See Bikhchandani and Sharma (2000), Choe et al. (1999), Kaminsky et al. (2001a), Borensztein and Gelos (2001), Froot et al. (2001), and Kim and Wei (2002).
1

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

213

to-late 1997, followed by the Russian default in August 1998 and the devaluation of the Brazilian real in January 1999. The mutual fund holdings are matched with a database of nearly 1000 stocks in the four largest Latin American markets. Equity portfolio holdings are likely to be revealing in light of evidence from Kaminsky et al. (2001b) who show only small changes in Latin American mutual funds cash holdings over this period. I find that over the 6-year period, mutual fund managers investing in Latin America prefer large, highly visible and liquid firms with strong profitability. Fund managers also prefer firms with low leverage, low dividend yields, and firms that are less likely to compete with Asian exports. These findings are consistent with similar studies on the U.S. and foreign developed markets, suggesting that mutual fund preferences for stock characteristics are largely robust to geography. In response to the Asian and Russian currency crises, the effects of certain firm characteristics on mutual fund stock ownership are different than in non-crisis years. Funds increase their holdings of ADRs and reduce their holdings of firms that operate in similar industries as Russias main exports. My findings suggest that firm attributes associated with trade links are among the key factors that influence portfolio choice in a developing region during crises. This result is consistent with the findings of Forbes (2004) and Bekaert et al. (2005), who show that trade channels contribute to the spread of crises across regions. The remainder of this paper is organized as follows. Section 2 develops an empirical model of investor behavior and puts forth a series of hypotheses concerning differences in mutual fund preferences between crisis and non-crisis periods. Section 3 describes the data used in the study, and Section 4 presents the determinants of mutual fund stock ownership. Section 5 concludes and offers suggestions for future work.

2. Empirical model and hypotheses 2.1. Empirical model The approach I take in this paper is to estimate the quantity of a firms outstanding equity held by dedicated Latin American mutual funds in a given year during or surrounding the financial crises. In the basic specification, holdings of outstanding equity are assumed to be a function of firm characteristics. Additional specifications include a set of dummy variables representing the crisis years and a set of firm-characteristic/crisisperiod interaction terms. For ease of exposition, the present discussion will center on the basic specification. The dependent variable is the proportional mutual fund ownership of a particular firms shares in a given year. Although many mutual funds voluntarily disclose their holdings on a monthly basis to tracking services such as Morningstar, the Securities and Exchange Commission only requires semi-annual reporting, in accordance with the funds fiscal year-end. As a result, the portfolio holdings of the sample funds will be at different dates, depending on the funds fiscal year and the timeliness of reporting to Morningstar. Following Falkenstein (1996), I calculate the dependent variable as the aggregate

214

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

percentage of a specific stock owned by the sample of Latin American mutual funds in a particular calendar year, ownershipit . This is defined as follows: ownershipit
Mi X sharesheldi;t m outstandingi;tm m1

where sharesheldi,tm represents the number of shares held of stock i by fund m at time t m , and outstandingi,tm is the total number of shares outstanding of stock i at time t m . Time t m represents the date to which the portfolio data correspond to fund ms holding of stock i, and M i is the total number of Latin American equity funds that hold the stock. The dependent variable is calculated annually from 1996 through 2001. Over 75% of all sample firms are not held by any mutual funds. This implies that the value of the dependent variable, mutual fund stock ownership, clusters at zero. Ordinary least squares estimation does not account for the censored nature of the data, leading to biased coefficient estimates. Thus, I test the hypotheses using Tobit estimation, which accounts for the clustering at zero and leads to consistent estimates. Due to the panel nature of the data, the primary Tobit specification is random effects. Random effects assume that any unobserved heterogeneity present among the Latin American stocks is uncorrelated with the explanatory variables. This may not be a valid assumption. A firm with more block ownership, for instance, could either benefit or harm minority shareholders, depending on the composition of the blockholders and whether expropriation is more prevalent by the firms management or by governmental authorities. Mitton (2002), for example, finds that firms with outside blockholders experienced higher stock returns in Asia during the 19971998 crisis. In Latin America, data on the ownership composition of specific firms is limited. Correlation between block ownership and the incidence of expropriation could therefore cause a downward bias in the coefficient estimates in the model, since the composition of the blockholders in the sample is unknown and a firms sensitivity to corruption is unobservable. Although fixed-effects estimation does not make the assumption that unobserved heterogeneity is uncorrelated with firm attributes, this specification cannot be easily implemented with a Tobit model. In addition, Greene (2003) finds that the parameters in the fixed-effects model will be biased when the time series is small. Thus, it is not clear that fixed-effects are the preferred specification here. McDonald and Moffitt (1980) show that the coefficient estimates generated from the Tobit specification can be decomposed into two parts. One part measures the effect of the independent variables on the probability of the dependent variable being above zero, and the other part measures the marginal effect conditional upon a positive value of the dependent variable. This decomposition is potentially important in this study, since aggregate mutual fund stock ownership is small for the majority of firms in the sample. Section 4 examines this decomposition in more detail. 2.2. Hypotheses The primary objective of this study is to determine whether the effect of firm characteristics on stock ownership by mutual fund managers in Latin American markets is

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

215

different in response to a period of financial turmoil relative to a period of tranquility. Because of the relatively unique nature of the recent financial crises, research has not established clear predictions on the firm attributes that foreign portfolio investors in emerging markets should value most highly during a turbulent period. I expect U.S.-based mutual fund managers investing in Latin America to be primarily concerned with seeking efficient portfolios while adapting to cash outflows (for open-end funds) or discounts to net asset value (for closed-end funds). Assuming that fund managers use firm characteristics to generate expectations about risk and return, I predict that firm attributes provide different signals about what risk and return will be in a financial crisis than they do in tranquil times. For instance, large firms are generally less risky than small firms. During a crisis, large firms could become more desirable to fund managers due to greater liquidity. If so, this finding would suggest that the risk-return tradeoff of large firms is more favorable during crises. Characteristics associated with asymmetric information, financial health, trade channels, and governance are likely to be important determinants of mutual fund stock ownership. Furthermore, I predict that fund managers perceive the effect of these firm characteristics on shareholder wealth and risk differently in crises versus non-crisis periods. The variables used to test the hypotheses are defined in Appendix A and explained more fully below. 2.2.1. Asymmetric information Merton (1987) hypothesizes that investors with incomplete information choose familiar securities. Grinblatt and Keloharju (2001) suggest that foreigners suffer from an informational disadvantage in investing abroad due to language, culture, and distance barriers. Research has focused recently on these implicit barriers, in light of a reduction of external barriers such as transaction costs and regulation. During a financial crisis, Johnson et al. (2000) indicate that investor confidence falls due to perceived weaknesses in the legal institutions of developing markets. Less certainty in a developing regions investment environment suggests that information asymmetry among foreign investors is greater during crises relative to tranquil periods. Variables such as firm size and whether a firm is cross-listed on a U.S. stock exchange have been used in several studies, including Dahlquist and Robertsson (2001) and Lang et al. (2003) to test for asymmetric information. Within the U.S., Falkenstein (1996) finds that mutual funds prefer stocks with high profiles, since these stocks require lower search costs and have less uncertainty in risk estimation. During crises, if mutual fund managers perceive greater uncertainty and are subject to greater volatility in their flows, this perception is reflected in the types of firm attributes they value. I expect that characteristics associated with high visibility will become more important to mutual fund managers in a crisis than in a tranquil period, since a crisis increases the difficulty in assessing a stocks risk. The inclusion of a firm in a major stock index is one firm characteristic associated with high visibility. Covrig et al. (2001) find that firms that are components of a stock index are associated with greater stock ownership by foreign mutual fund managers, which the authors attribute to increased firm recognition. Although the goal of actively managed funds is to outperform their respective benchmark indexes, the increased instability in a

216

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

region during a crisis should be accompanied by higher search costs for individual stocks. Thus, I predict that index stocks become more desirable during a crisis compared to a period of tranquility. Many studies document the preference towards large firms by both foreign and institutional investors.2 Besides greater investor recognition, large firms are also more liquid than small firms. There may, however, be reasons that large firms are undesirable in a developing market, particularly during a crisis period. Schiffer and Weder (2001) suggest that smaller firms may be exposed to less country risk than large firms. Small firms in countries with weak legal environments can more easily avoid taxes and regulation due to informal arrangements. In contrast, large firms may be more vulnerable to corruption by government officials due to their higher visibility and generally higher profits. Gaviria (2002) finds that while corruption is common for firms of all sizes in Latin America, smaller firms tend to be more severely affected. Thus, the effect of firm size on stock ownership should be greater in crisis periods relative to tranquil periods. Cross-listed firms are also associated with greater foreign recognition. Lang et al. (2003) find that non-U.S. firms that are listed on U.S. exchanges experience greater analyst coverage, and thus greater investor recognition, relative to other non-U.S. firms. Several studies suggest that cross-listed firms also have better governance.3 Like large firms, cross-listed firms tend to be more liquid. Kaminsky et al. (2000) find that during crises U.S.-based Latin American open-end fund managers tend to liquidate their most liquid positions. Due to their high liquidity, ADRs should be easier to sell than non-ADRs in order to meet fund redemptions. This suggests that while ADRs have desirable attributes that could lead to increased ownership, fund managers may actually exhibit weakened preference to ADRs due to redemption needs or perceived susceptibility of ADRs to contagion. The difference in the effect of cross-listed firms on mutual fund stock ownership between crisis and non-crisis periods is therefore uncertain. 2.2.2. Financial health Financial variables provide insight into the health of a firm, which fund managers pay close attention to in their portfolio-making decisions. Three variables of interest are a firms return on assets, its current ratio, and its leverage ratio. Dahlquist and Robertsson (2001) use the latter two variables as proxies for short-term and long-term financial distress. The inclusion of the current ratio is motivated by Forbes (2004), who suggests that crises could be transmitted to firms in other countries via a credit crunch due to lack of liquidity. It is possible that the financial crises resulted in a dflight to qualityT response by mutual fund managers, leading to increased ownership. At the same time, stocks with strong financial health may also be easiest to liquidate, leading to reduced ownership in response to crises. Similar to the opposing effects of cross-listed firms on portfolio holdings, the difference in the effect of financial health variables on mutual fund stock ownership between crisis and non-crisis periods is uncertain.
See Falkenstein (1996), Del Guercio (1996), Kang and Stulz (1997), Dahlquist and Robertsson (2001), Gompers and Metrick (2001), and Aggarwal et al. (2003). 3 See Coffee (2002), Mitton (2002), Klapper and Love (2002), Reese and Weisbach (2002), and Doidge et al. (2004).
2

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

217

2.2.3. Trade channels Forbes (2004) finds that trade channels contributed to the transmission of the Asian and Russian crises to other regions. Among her findings is that firms whose main product line was in the same industry as a major export from East Asia and firms competing with Russian exports experienced lower abnormal stock returns during the crises. She attributes these findings to product competitiveness and income effects. Product competitiveness occurs when the devaluation of a countrys currency (as occurred in Asia) causes that countrys exports to be relatively cheaper in world markets, and therefore reduces the competitiveness for other countries that compete with those exports. Income effects occur when the devalued currency reduces the countrys purchasing power, so firms that export to the affected country will suffer from reduced demand for their goods and services. Chriszt (1999) indicates that while exports contribute only a modest amount to Latin American economies, a number of countries depend on oil and metals for export earnings. Some countries such as Chile depend heavily on mineral exports to Asia, and mineral products are one of Russias main exports. This suggests that firms perceived to be most vulnerable to both types of trade channel effects should be relatively less attractive to investors. The industry of each Latin American company is identified via its North American Industry Classification (NAIC) code.4 Appendix B provides Forbes (2004) list of the major exports of the main crises zones. I hypothesize that mutual fund stock ownership in Latin America should be negatively associated with firms operating in similar industries as those of Asias and Russias main exports in crises relative to non-crisis periods. 2.2.4. Governance Corporate governance is also an important element of investment decisions. Firms with good governance structures contribute to firm value by aligning the interests of stockholders and managers. Legal systems to protect shareholders vary greatly among countries, suggesting that governance concerns play an important role in portfolio choice overseas. Although the ownership restrictions imposed on mutual funds limit their role in corporate governance, like all investors mutual fund managers choose investments that they expect to provide a fair return. Since minority shareholders rights are frequently not well protected in emerging markets, it benefits managers to choose firms with characteristics associated with low agency costs. Studies such as Klapper and Love (2002) and Aggarwal et al. (2003) find that firms with better corporate governance in emerging markets have higher market valuations and attract more investment by U.S.based mutual funds. Thus, I expect governance concerns to influence firm ownership by mutual fund managers in Latin America during financial crises. Studies of corporate governance generally examine variables such as the composition and compensation of the board of directors as well as the percentage of inside ownership. Much of this data is difficult or impossible to obtain for Latin American firms. Of the four markets in my sample, only Brazil and Chile report ownership data. The disclosure indicates the

Data on the share of exports to specific countries by individual Latin American firms is not available.

218

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

ownership percentage of blockholders (defined as shareholders owning 5% or more of the firms shares), but inside ownership and board of director information are not reported. For Brazil and Chile, the degree of ownership concentration could provide indirect evidence regarding corporate governance concerns. As Holderness (2003) indicates, research has not definitively determined whether outside blockholders increase or decrease firm value. This is due to two potentially offsetting effects: improved monitoring of management by blockholders versus the private benefits of control. La Porta et al. (2000) find that French civil law countries (which characterize the legal system in Latin America) have the weakest protection of outside investors, and state that concentrated ownership is needed in these countries as a commitment to limit expropriation. If fund managers perceive block ownership as a favorable governance characteristic in Latin America, I expect the effect of block ownership on mutual fund stock ownership in Brazil and Chile to be greater during crises relative to non-crisis periods.

3. Data and summary statistics 3.1. Data I choose U.S. institutions to examine the role of investor behavior during crises, since they represent one of the largest investor groups in foreign securities. Aggarwal et al. (2003) indicate that U.S. institutions are the worlds largest source of equity capital. Davis and Steil (2001) indicate that approximately 50% of flows to emerging markets in the 1990s were portfolio flows by institutional investors. The use of dedicated Latin American mutual funds is designed to reduce confounding factors that can influence portfolio decisions within the mutual fund universe. For example, broadening the sample to include all emerging market funds introduces the possibility that fund managers are making regional currency bets in their decision to invest in Latin America. In this situation, examining firm characteristics to increase understanding of investor reaction to externally based crises would be less informative, since these fund managers may be basing their decisions more heavily at the country level than at the firm level. Since the funds in my sample are dedicated to the region, the attributes of the individual firms should be the primary factors behind their portfolio choices. An additional advantage to studying the behavior of dedicated Latin American funds is that the investor group remains relatively constant over the time period. The sample period covers a pre-crisis year (1996), followed by the Asian and Russian crises (19971998), the Brazilian crisis (1999), and a post-crisis period (20002001). These periods therefore provide an opportunity to contrast portfolio preferences between crisis and non-crisis years for a reasonably homogeneous group of investors. I identify U.S.-based Latin American equity mutual funds from Morningstar for openend funds and from CDA/Wiesenbergers Investment Companies Yearbook (19962001) for closed-end funds. These funds and their portfolio holdings are identified and collected on an annual basis from 1996 through 2001. Table 1 lists the funds included in the sample with numbers indicating the months in which portfolio data are reported. This list consists of distinct portfolios only (so that multiple share classes of funds are excluded) and

S. Elkinawy / Emerging Markets Review 6 (2005) 211237 Table 1 List of U.S.-based Latin American equity mutual funds Fund type Fund name Inception date Year

219

1996 1997 1998 1999 2000 2001 Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Open Closed Closed Closed Closed Closed Closed Closed Closed Closed Closed Closed ABN AMRO Latin Amer Eq Jun 96 AIM Latin America growth Aug 91 BT investment Latin Amer Eq Oct 93 Chase Vista Latin Amer Eq Dec 97 Evergreen Latin America Nov 93 Excelsior Latin America Dec 92 Federated Latin Amer Grth Feb 96 Fidelity Adv Latin America Dec 98 Fidelity Latin America Apr 93 Govett Latin America Mar 94 Invesco Latin American Grth Feb 95 Ivy South America Nov 94 Kemper Latin America Dec 97 Merrill Lynch Latin Amer Sep 91 Montgomery Latin America Jun 97 Morgan Stan Ins LatinAm Jan 95 Morgan Stanley Latin Am Gr Dec 92 Nicholas-Apple Latin Am Nov 97 Offitbank Latin Amer Eq Sel Feb 96 Prudential Latin America Jun 98 Scudder Latin America Dec 92 T. Rowe Price Latin America Dec 93 TCW Galileo Latin America Eq Mar 93 Templeton Latin America May 95 Van Kampen Latin Amer Jul 94 Wright EquiFund-Mexico Aug 94 Argentina fund Oct 91 Brazil fund Apr 88 Brazilian equity fund Apr 92 Chile fund Sep 89 Emerging Mexico fund Jun 90 Latin America equity fund Oct 91 Latin America investment fund Aug 90 Latin American discovery fund Jun 92 Latin America smaller companies fund Nov 94 Mexico equity and income fund Aug 90 Mexico fund Jun 81 Total number of portfolios: 12 6 9 10 3 11 4 12 7 6 5 12 9 12 6 4 10 3 6 6 10 12 3 12 12 12 12 12 10 7 10 31 12 9 9 4 9 11 4 12 9 9 8 9 12 9 12 9 10 6 9 6 9 10 12 3 12 6 12 12 12 10 7 10 32 6 9 9 4 9 12 4 9 9 9 8 9 9 9 11 10 8 9 6 3 6 9 11 10 12 3 12 6 12 12 12 10 7 10 34 9 5 11 12 11 9 11 4 4 9 9 6 5 6 9 11 7 5 9 6 11 9 6 2 10 6 3 12 12 12 12 7 10 33 11 8 3

11 11 4 4 4 9 9 11 9 6 7 5 9 9 6 9 6 6 10 6 3 12 12 6 12 7 10 29

9 4 4 4

7 6 6 10 11 9 9 4 9 6 10 6 3 12 12 12 7 10 23

Numbers indicate month of portfolio disclosure. Source: Morningstar and the Securities and Exchange Commission.

excludes index funds in order to examine active portfolio decision-making by fund managers. Twenty-six open-end funds existed over the period. Eleven closed-end funds existed in 1996 but by the end of 2001 two funds had liquidated and one merged with another existing closed-end fund. Since mutual funds frequently undergo changes such as name, investment advisor, mergers into other funds, or liquidation I check for these events to ensure data integrity.

220

B
-5% 0% 5%

0%

5%

-15%

-10%

10%

15%

10%

15%

20%

-5%

-35%

-30%

-25%

-20%

-15%

-10%

Jan-95

May-95

Sep-95

Jan-96

May-96

Sep-96

Jan-97

May-97

Sep-97

Jan-98

May-98

Sep-98

Jan-99

May-99

Sep-99

Jan-00

May-00

Sep-00

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

Jan-01

May-01

Ja nM 95 ay Se 95 p9 Ja 5 nM 96 ay Se 96 p9 Ja 6 nM 97 ay Se 97 p9 Ja 7 nM 98 ay -9 Se 8 p9 Ja 8 nM 99 ay Se 99 p9 Ja 9 nM 00 ay Se 00 p0 Ja 0 nM 01 ay Se 01 p01

Sep-01

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

221

The funds holdings are obtained from Morningstar and the U.S. Securities and Exchange Commissions EDGAR system. Both Morningstar and the Securities and Exchange Commission indicate whether the holding is an ADR. The primary source for ADR ratios is the Bank of New York, which I use to convert the number of ADR shares into underlying firm shares. Similar to Falkenstein (1996), I use the most recently reported portfolio holdings in the Morningstar database as of year-end for the open-end funds. For the closed-end funds and for missing open-end portfolio data, I use the annual shareholder report (N-30D filing) from the Securities and Exchange Commission. Since the majority of the funds report in the second half of the year, the implication is that the portfolios analyzed in the crisis years reflect choices made subsequent to the onset of the crises. The primary source for firm financial data is Economatica, a private company that specializes in the collection of Latin American company data. This source tracks detailed financial data on every publicly listed firm from 1986 (or later if a firm became public at a later date). In addition, de-listed firms are maintained in their database, allowing for analysis of holdings that are no longer listed on the stock exchanges. The universe of firms available for mutual fund investment includes all stocks in the four main Latin American markets tracked in the Economatica database. The four markets include Argentina, Brazil, Chile, and Mexico and consist of over 950 publicly traded stocks in the Economatica universe. With few exceptions, the firms listed in the four markets were freely open to foreign investment in 1996, the starting period for this study. Mexico and Brazil make up the largest percentage of the funds holdings throughout the 6year period. Argentina, Brazil, Chile, and Mexico collectively represent over 90% of the market value of the funds holdings over the sample period. I choose the 1996 to 2001 period because it encompasses the recent global crises and the ensuing effect on mutual fund behavior. Bekaert et al. (2005) find that unlike the Mexican crisis, the Asian crisis worsened contagion in Latin America. Bazdresch and Werner (2000) indicate that by 1996 markets had recovered from the Mexican crisis, making it a suitable starting period for examining the crises that followed. Fig. 1A indicates that open-end mutual funds experienced outflows beginning in the second half of 1997 that persisted through late 1998/early 1999, with the devaluation of the Brazilian real. Fig. 1B shows that the discounts of closed-end funds exhibited a relatively continuous increase in magnitude over the period, with the largest discounts occurring in 1998 and a modest recovery beginning in the middle of 2000. Interestingly, the total market capitalization of Latin America grew between 1996 and 1997. This is consistent with the fact that the aggregate market value held by the funds grew from $4 billion in 1996 to $6 billion in 1997, an increase of 50%. This increase is likely due to a combination of increased open-end fund flow in the first half of 1997 combined with appreciation of asset values. By the end of 1998 the market value of the funds holdings fell below 1996 levels, likely in reaction to the Russian crisis. My sample period provides an opportunity to examine portfolio decisions made in response to the two most widespread crises that were not Latin American in origin.
Fig. 1. (A) Aggregate dollar flow of open-end Latin American mutual funds scaled by total net assets, 19952001. Flow is computed as the percentage monthly growth in total net assets less capital appreciation. Source: The Center Research in Security Prices Mutual Funds Database. (B) Average premium/discount of closed-end Latin American mutual funds, 19952001. Source: Barrons National Business and Financial Weekly.

222

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

Table 2 Summary statistics of mutual fund stock ownership and firm characteristics, 19962001 N Mutual fund stock ownership (%) Mutual fund stock ownership (%)a Total assets ($millions) ADR program (%) S&P index (%) Current ratio (%) Return on assets (%) Dividend yield (%) Leverage (%) Asian exports (%) Russian exports (%) Share turnover (%) Beta Stock return (%) Free float (%) 5715 1259 4540 5715 5715 4438 4492 3720 4138 5715 5715 3440 2961 3954 3013 Mean 0.35 1.59 1540 10.76 3.74 9.13 2.20 4.95 25.18 38.64 5.56 0.09 0.62 7.38 31.22 Median 0 0.71 257 0 0 1.20 2.60 1.90 21.20 0 0 0.04 0.60 -8.90 26.30 Std. dev. 2.08 4.20 5780 30.99 18.99 292.12 114.01 11.77 30.52 48.70 22.93 0.43 0.39 101.28 23.84

Mutual fund stock ownership is calculated as the aggregate percentage of shares held by U.S.-based Latin American equity mutual funds of a publicly listed firm in Argentina, Brazil, Chile, or Mexico in a calendar year. The data on fund ownership are collected from Morningstar and the Securities and Exchange Commissions EDGAR database. The data on firm characteristics are collected from Economatica and the Bank of New York. The sample of firms excludes Mexican banks (NAIC code 52), resulting in 953 firms over the 6-year period. Firm characteristics are defined in Appendix A. aMutual fund ownership on non-zero holdings only.

3.2. Summary statistics Table 2 provides summary statistics for the firm attributes along with the dependent variable, firm ownership, over the 1996 to 2001 period. The mean and median size of a Latin American firm is $1.5 billion and $257 million, respectively, indicating that the mean is highly skewed by a few very large firms. Approximately 11% of the firms have ADR programs, while 4% are part of the Standard and Poors Latin American 40 index. The average turnover ratio and beta are only 0.09% and 0.62, suggesting that many of these stocks trade infrequently. The average free float percentage in Brazil and Chile is 31%, indicating that close to 70% of the shares are held by blockholders. Latin American mutual funds hold a small percentage of firm equity, as the mean percentage held of a Latin American companys stock is only 0.3% of the shares outstanding. However, since 70% of the shares are unavailable to minority shareholders, Latin American funds hold about 1% of the total shares available. This percentage is non-trivial, given the small number of funds.5

4. The determinants of Latin American mutual fund stock ownership Table 3 presents the baseline results of the random effects Tobit model of stock ownership. These equations pool observations across crisis and non-crisis years to
Latin American funds also hold approximately 1% of the market value of all shares traded in the main Latin markets.
5

S. Elkinawy / Emerging Markets Review 6 (2005) 211237 Table 3 Random effects Tobit model of Latin American mutual fund stock ownership, 19962001 Model (1) Tobit coeff. Total assets Total assets squared ADR program S&P index Current ratio Return on assets Dividend yield Leverage Leverage squared Asian exports Russian exports Share turnover Beta Stock return Interest rates Foreign exchange rate GDP growth rate U.S. market return Year 1997 Year 1998 Year 1999 Year 2000 Year 2001 Constant Percentage of uncensored obs. N Log likelihood 0.7433 0.8676 1.9938 0.0112 0.0473 0.0316 0.0130 0.5187 0.7045 0.3743 1.2767 0.0004 0.0308 0.0004 0.0186 0.0254 p-value 0.000 0.007 0.000 0.778 0.000 0.023 0.105 0.117 0.140 0.000 0.001 0.727 0.067 0.967 0.444 0.000 Model (2) Tobit coeff. 0.8027 1.1717 2.0951 0.0026 0.0483 0.0312 0.0100 0.6433 0.5947 0.3498 1.3366 0.0009 p-value 0.000 0.000 0.000 0.948 0.000 0.026 0.211 0.071 0.203 0.000 0.000 0.425 Model (3) Tobit coeff. 5.3633 0.1130 1.1516 2.2696 0.0036 0.0499 0.0318 0.0366 0.0008 0.7457 0.5238 0.3589 1.3442 0.0009

223

p-value 0.001 0.005 0.001 0.000 0.925 0.000 0.022 0.119 0.036 0.032 0.256 0.000 0.000 0.431

15.5445 0.2844 2064 1713.48

0.000

0.4158 1.3681 1.2221 1.5995 2.1244 15.6409 0.2844 2064 1699.79

0.124 0.000 0.000 0.000 0.000 0.000

0.4235 1.3867 1.2298 1.5996 2.1127 61.7057 0.2844 2064 1693.37

0.117 0.000 0.000 0.000 0.000 0.000

In models (2) and (3), the omitted year is 1996. Variable definitions are provided in Appendix A. Dependent variable: Aggregate proportional ownership of shares held of a Latin American stock by mutual fund managers in a calendar year.

determine overall preferences for firm characteristics over the period.6 In model 1, I include control variables for macroeconomic conditions in addition to the firm characteristics. The macroeconomic variables for each country include the level of interest rates, the percentage change in foreign exchange rates relative to the U.S. dollar, the growth rate of gross domestic product, and the returns of the U.S. stock market (all are adjusted for inflation). The negative coefficient on interest rates suggests that mutual fund stock demand is lower when local interest rates increase. This is consistent with the fact that government authorities in Latin America raised interest rates during the crises to reduce capital outflows, signaling weaknesses in the regions economic fundamentals. Interestingly, the coefficient on the U.S. market return is positive, suggesting that mutual fund stock ownership in Latin America increases with the returns of the U.S. stock market.
The regression analyses omit Mexican banks (NAIC code 52) due to an industry-wide change in accounting methods in 1998. The Mexican banking industry represents about 2% of all firms available in the four markets.
6

224

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

This finding may indicate that the U.S. market serves as a proxy for expected global market conditions or that a leader/follower relationship exists between the U.S. and Latin American markets. Controlling for macroeconomic conditions, the positive coefficients on total assets, ADR program, S&P index, return on assets, and share turnover in Table 3 indicate that managers prefer large, highly visible firms with strong financial health and high liquidity. The positive coefficient on beta suggests that fund managers prefer stocks with high systematic risk. Bennet et al. (2003) find that institutional investors, particularly less conservative investors like mutual funds, have shifted their preferences toward riskier securities over time. However, another possibility is that non-synchronous trading is contributing to this result. Stocks that trade more frequently will have higher betas, suggesting that beta is capturing the degree of trading activity. The negative coefficient on leverage suggests aversion toward firms that are more likely to experience financial distress. These results are similar to those documented in studies conducted on other markets, suggesting institutional investor preference is largely robust to geography and time period. The negative coefficient on the dividend yield is consistent with studies such as Dahlquist and Robertsson (2001), who find that foreign investors prefer growth firms. It has been argued that the dislike for dividends may be motivated by tax considerations. Three of the four Latin American markets withhold a portion of dividends paid to foreign investors. As Christoffersen et al. (2003) indicate, the U.S. grants tax credits to taxable accounts for foreign taxes paid, so that these accounts can at least partially offset the withholding. However, mutual funds are not eligible for the tax credits, so the foreign dividend withholding tax reduces the funds returns. In model 2 of Table 3, I replace the macroeconomic variables with year dummy variables in order to control for the effect of time on mutual fund stock ownership. The results are similar to those of model 1, suggesting that the year dummy variables capture the macroeconomic conditions in the four markets.7 In model 3, I examine more closely the relation between firm size and ownership, as well as between leverage and ownership. Dahlquist and Robertsson (2001) find that both foreign and domestic institutional investors prefer large firms in Sweden, leading the authors to conclude that this preference is an institutional investor bias rather than simply a foreign investor bias. However, firms that are too large could be undesirable to minority shareholders in an emerging market due to greater agency costs associated with less ability to monitor the actions of the firms management, controlling shareholders, or governmental agencies in the home country. I investigate this possibility further by including a quadratic term for total assets in model 3. The negative coefficient on the quadratic term confirms that mutual funds do exhibit a non-linear preference toward firm size, suggesting support for the agency hypothesis of large firms. I also investigate whether firm leverage exhibits a non-linear effect on mutual fund stock ownership. As Jensen (1986) argues, debt can serve as a governance mechanism by reducing
7 The fact that a model including both time dummy variables and macroeconomic variables leads to multicollinearity between the two sets of variables strengthens this argument. Future specifications, therefore, include only controls for time.

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

225

the agency costs of free cash flow through the contractual obligation associated with interest payments. Harvey et al. (2004) find that debt creates value for emerging market firms that have high expected overinvestment and managerial agency problems. However, too much debt increases the risk of financial distress. Table 3 indicates that leverage has a significant negative effect on mutual fund ownership, although the relationship does not appear to be non-linear at conventional significance levels. Since the mutual funds own equity in a relatively small number of Latin American firms, it is likely that firm attributes have a much stronger effect on the decision to purchase a stock than on the quantity of the stock purchased. I investigate this possibility by decomposing the marginal effects of the firm attributes using the procedure developed by McDonald and Moffitt (1980). Table 4 presents the decomposition for each of the variables shown in model 3 of Table 3. As suspected, each coefficient has a greater marginal effect on the probability of a stock being held than on the level of stock ownership. For example, a 1% increase in total assets results in a 0.55 percentage point increase in the probability that the stock is held by mutual funds, while a similar increase in total assets results in a 0.38 percentage point increase on the level of stock ownership, given that the stock is owned.

Table 4 McDonaldMoffitt decomposition of marginal effects, 19962001 Marginal effect on the probability of holding a stock Total assets Total assets squared ADR program S&P index Current ratio Return on assets Dividend yield Leverage Leverage squared Asian exports Russian exports Share turnover Beta Stock return Year 1997 Year 1998 Year 1999 Year 2000 Year 2001 0.5456 0.0115 0.1171 0.2309 0.0004 0.0051 0.0032 0.0037 0.0001 0.0759 0.0533 0.0365 0.1367 0.0001 0.0431 0.1411 0.1251 0.1627 0.2149 Marginal effect on the level of stock ownership, given positive ownership 0.3825 0.0081 0.0821 0.1619 0.0003 0.0036 0.0023 0.0026 0.0001 0.0532 0.0374 0.0256 0.0959 0.0001 0.0302 0.0989 0.0877 0.1141 0.1507

The McDonaldMoffitt estimation procedure decomposes the coefficient estimates generated from a Tobit specification into two parts. One part measures the effect of the independent variables on the probability of mutual fund stock ownership being positive, and the other part measures the marginal effect conditional on ownership being positive. The omitted year is 1996. Variable definitions are provided in Appendix A. Dependent variable: Aggregate proportional ownership of shares held of a Latin American stock by mutual fund managers in a calendar year.

226

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

The results in this section indicate that the portfolio choices of foreign investors are generally consistent with those of previous studies, suggesting that investor preference for firm characteristics is insensitive to geographic location. In addition, I find that firm attributes have a greater influence on a fund managers decision to hold a particular Latin American stock than on the quantity of the stock held. Next, I evaluate whether preferences differ between crisis and non-crisis periods. 4.1. Mutual fund preferences in response to crises relative to non-crisis periods In this section, I investigate the proposition that the demand by mutual fund managers for particular firm characteristics is different in response to financial crises, relative to periods of tranquility. The purpose of these tests is to assess whether certain characteristics become relatively more or less desirable to mutual fund managers subsequent to financial turmoil originating in a different region. Since the objective of this study is to increase understanding of contagion across regions, the years of interest are 1997 and 1998, the period encompassing the Asian and Russian crises. In Tables 5 and 6, I interact a crisis dummy variable representing the 19971998 period with the characteristics associated with the hypothesis of interest. The coefficients on the interacted terms represent the difference in the effect of the chosen variable on mutual fund stock ownership between the crisis period of 19971998 and the non-crisis years of 1996 and 19992001. Column 1 of Table 5 indicates that no significant shift toward large firms or S&P Latin American index firms occurs in response to crises. However, the positive coefficient on the ADR program dummy suggests that mutual fund managers move into stocks that trade on U.S. exchanges during crises. This finding is consistent with a variety of interpretations, including more information, greater liquidity, and potentially better corporate governance of cross-listed firms relative to firms that are only locally listed. Interestingly, upon investigating the two fund types separately, the preference toward ADRs during crises is evident among the closed-end funds, with or without controlling for country fixed-effects. Since redemption is not a concern for these funds, it is not clear that the shift is due primarily to liquidity reasons. I test the financial health hypothesis in column 2 using return on assets, the current ratio, and the leverage ratio as proxy variables. None of the variables cause significant portfolio shifts during crises. These findings are broadly consistent with Forbes (2004), who indicates that firms with greater reliance on debt during the Asian and Russian crises were not more adversely affected than other firms. In column 3, I investigate the effect of trade competition on mutual fund stock demand. No significant effect of Asian export competitors on ownership is apparent in response to the crises. Unlike Asian export competitors, fund managers favored Russian export competitors in the non-crisis period but reduced their holdings of these firms in response to the events occurring in 1997 and 1998. However, the p-value of 0.11 is only marginally significant at conventional levels. I investigate the effect of governance as measured by the free float percentage in Brazil and Chile in column 4. Family-dominated ownership structures are common in emerging markets. As minority shareholders, mutual funds are subject to the risk of expropriation by

Table 5 Random effects Tobit model of Latin American mutual fund stock ownership in crisis versus non-crisis periods Information asymmetry Tobit coeff. Total assets ADR program S&P index Current ratio Return on assets Dividend yield Leverage Asian exports Russian exports Share turnover Beta Stock return Free float Total assets * crisis ADR program * crisis S&P index * crisis Current ratio * crisis ROA * crisis Leverage * crisis Asian exp * crisis Russian exp * crisis Free float * crisis Crisis dummy Constant Percentage of uncensored obs. N Log likelihood 0.7710 0.5134 1.8840 0.0170 0.0447 0.0370 0.0216 0.4775 0.6331 0.3586 1.7476 0.0001 0.1454 0.7092 0.5420 p-value 0.000 0.120 0.000 0.663 0.000 0.007 0.005 0.139 0.187 0.000 0.000 0.935 0.257 0.080 0.320 0.0504 0.0179 0.0001 0.524 0.375 0.991 0.1913 0.8852 2.9836 15.9658 0.2844 2064 1727.64 0.250 0.000 0.2600 15.1597 0.2844 2064 1729.58 0.536 0.000 0.4579 14.9935 0.2844 2064 1727.99 0.602 0.110 0.040 0.000 0.0119 0.5680 21.7643 0.2259 1567 1041.35 0.176 0.146 0.000 Financial health Tobit coeff. 0.7262 0.7130 2.1470 0.0270 0.0500 0.0374 0.0223 0.4878 0.6797 0.3596 1.7644 0.0001 p-value 0.000 0.023 0.000 0.572 0.000 0.007 0.010 0.136 0.160 0.000 0.000 0.944 Trade channels Tobit coeff. 0.7191 0.7062 2.2003 0.0172 0.0456 0.0377 0.0224 0.4204 0.9674 0.3634 1.7050 0.0001 p-value 0.000 0.024 0.000 0.662 0.000 0.007 0.004 0.230 0.063 0.000 0.000 0.955 Governance (Brazil and Chile only) Tobit coeff. 0.8754 0.9889 3.2250 0.0040 0.0420 0.0313 0.0168 0.7030 1.1477 0.0846 1.7003 0.0023 0.0228 p-value 0.000 0.010 0.000 0.931 0.001 0.034 0.068 0.110 0.046 0.467 0.000 0.136 0.007

S. Elkinawy / Emerging Markets Review 6 (2005) 211237 227

Crisis period is defined as the years 19971998. Coefficients on interaction terms represent the difference in the effect of the firm characteristic on mutual fund stock ownership between crisis and non-crisis periods. Variable definitions are provided in Appendix A. Dependent variable: Aggregate proportional ownership of shares held of a Latin American stock by mutual fund managers in a calendar year.

228

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

Table 6 Random effects Tobit model of Latin American mutual fund stock ownership in crisis versus non-crisis periods (all variables) All four countries Tobit coeff. Total assets ADR program S&P index Current ratio Return on assets Dividend yield Leverage Asian exports Russian exports Share turnover Beta Stock return Free float Total assets * crisis ADR program * crisis S&P index * crisis Current ratio * crisis ROA * crisis Leverage * crisis Asian exports * crisis Russian exports * crisis Free float * crisis Crisis dummy Constant Percentage of uncensored obs. N Log likelihood 0.7761 0.5249 1.9578 0.0252 0.0521 0.0382 0.0226 0.4409 0.9408 0.3597 1.7175 0.0000 0.1378 0.6504 0.5783 0.0425 0.0261 0.0004 0.1606 0.8449 3.0635 16.1048 0.2844 2064 1724.96 p-value 0.000 0.116 0.000 0.585 0.000 0.006 0.009 0.212 0.070 0.000 0.000 0.988 0.301 0.113 0.292 0.592 0.204 0.974 0.679 0.131 0.258 0.000 Brazil and Chile only Tobit coeff. 0.9900 0.6150 3.5312 0.0057 0.0416 0.0292 0.0187 0.6215 1.5150 0.0839 1.6084 0.0017 0.0180 0.2507 0.9728 0.8902 0.0132 0.0223 0.0121 0.0361 1.3181 0.0074 5.2448 23.8514 0.2259 1567 1033.86 p-value 0.000 0.126 0.000 0.909 0.001 0.051 0.066 0.193 0.021 0.473 0.000 0.268 0.038 0.109 0.046 0.219 0.883 0.468 0.431 0.938 0.037 0.415 0.109 0.000

Crisis period is defined as the years 19971998. Coefficients on interaction terms represent the difference in the effect of the firm characteristic on mutual fund stock ownership between crisis and non-crisis periods. Variable definitions are provided in Appendix A.

a firms managers or controlling shareholders due to relatively weak legal protection by the courts. The composition of the blockholders is unknown in this sample, but in Latin America it is likely dominated by insiders. Thus, fund managers should be averse to firms with high ownership concentration. Alternatively, in a crisis insiders can potentially benefit minority shareholders due to their ability to deal with government officials. According to Gaviria (2002), in the presence of corruption foreign direct investors will choose to associate with local partners because of their knowledge of the bureaucratic system. If firms with controlling shareholders are perceived to have close ties with political officials, portfolio investors could view this favorably during crises if they associate high ownership concentration with less risk of government expropriation. The positive coefficient on free float indicates that mutual funds generally prefer less concentrated ownership in non-crisis periods, but no significant shift occurs in response to crises. However, fund type matters in this instance. Open-end mutual fund managers do

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

229

reduce their holdings of firms with highly dispersed ownership. Since the closed-end funds do not exhibit this behavior, it is likely that liquidity concerns are driving this result for the open-end funds, since firms with highly dispersed ownership should be the easiest to sell during crises. Since a number of the variables used to test the hypotheses are not independent, Table 6 presents the results of the regressions when all of the interacted variables are combined. The first specification examines the four markets collectively. Although with both fund types the p-value of 0.113 on the ADR Program * Crisis interaction term is not significant at conventional levels, the preference toward cross-listed firms is still significant among the closed-end funds when analyzed separately. This finding suggests that features besides liquidity are important to fund managers. The second specification includes the free float variable for Brazil and Chile. This model does not indicate that fund managers reduce their holdings of firms with highly dispersed ownership in response to crises. However, fund managers increase their holdings of ADRs and reduce their holdings of Russian export competitors, similar to the findings in Table 5. 4.2. The Brazilian crisis Tables 5 and 6 provide suggestive evidence that a financial crisis originating in a different region causes investors to re-evaluate the desirability of certain firm attributes within their own region. In the previous analyses, I define 1999 as a non-crisis year in order to gain insight into how fund managers react to crises originating across regional borders. One unanswered question, however, is how does a crisis originating within a region affect the desirability of firm characteristics? In an unreported specification, I conduct the tests shown in Table 6 by redefining the crisis period as the year 1999 in order to examine the response of mutual fund managers to the Brazilian devaluation in January of that year. Unlike the 19971998 crises, the Brazilian crisis did not cause mutual funds to significantly alter their preferences for particular firm attributes. This result is perhaps not surprising, due to expectations prior to the devaluation of the real. On March 12, 1999, Michael Chriszt from the Federal Reserve Bank of Atlanta stated: bBrazils troubles did not begin in January 1999. The precipitant for Brazils current problemsand Latin Americas for that mattereffectively occurred nearly two years ago.Q Chriszt indicates that investors began to sell their Brazilian holdings in 1998 due to the structural similarities between Brazil and the other crisis countries. The IMF approved a $41.5 billion loan in November 1998, but the move was insufficient to prevent the subsequent devaluation in January 1999. These events suggest that unlike the Asian crisis, the problems in Brazil were anticipated prior to the collapse of its currency. 4.3. Country effects The results shown in the prior tables are pooled across countries and do not incorporate country fixed-effects. However, the results are largely robust to their inclusion. One disadvantage of pooling is that it imposes the restriction of common slopes across countries. This assumption may be too restrictive because the countries differ in many respects, such as macroeconomic policies and tax laws. For example, of the four Latin

230

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

markets, only Argentina did not impose a foreign withholding tax on dividends during the sample period. If the aversion toward dividends is due to tax concerns, then controlling for other characteristics, we should not observe this aversion in Argentina. In addition, the results in Table 6 indicate that some differences in preferences become apparent when Brazil and Chile are analyzed separately. Therefore, examining stock ownership within specific countries provides a more flexible specification. In Table 7 I investigate whether any significant shift in preferences occurs within countries between crisis and non-crisis periods. The preference toward large firms is present in all of the countries in the non-crisis period, but fund managers reduce their holdings of large Mexican firms in response to crises. Interestingly, fund managers investing in Argentina are still averse to dividends in the non-crisis period. This suggests that growth may be a more important factor in stock choice than tax concerns.
Table 7 Random effects Tobit model of Latin American mutual fund stock ownership in crisis versus non-crisis periods by country Argentina Brazil Chile Mexico

Tobit coeff. p-value Tobit coeff. p-value Tobit coeff. p-value Tobit coeff. p-value Total assets 0.4783 ADR program 0.0241 S&P index 1.3619 Current ratio 0.5229 Return on assets 0.0813 Dividend yield 0.1090 Leverage 0.0033 Asian exports 0.6003 Russian exports 0.1041 Share turnover 0.3761 Beta 2.7989 Stock return 0.0020 Total assets * crisis 0.3557 ADR program * crisis 1.7351 S&P index * crisis 0.9242 Current ratio * crisis 0.6712 ROA * crisis 0.0811 Leverage * crisis 0.0678 Asian exp * crisis 0.8412 Russian exp * crisis 0.2375 Crisis dummy 9.8827 Constant 16.3320 Percentage of 0.3911 uncensored obs. N 179 Log likelihood 158.51 0.018 0.955 0.003 0.001 0.003 0.000 0.776 0.095 0.808 0.006 0.000 0.521 0.192 0.023 0.348 0.000 0.005 0.000 0.122 0.734 0.068 0.000 1.5541 0.3355 4.9554 1.0018 0.0537 0.0621 0.0015 0.2510 1.7218 0.1306 1.5639 0.0037 0.3494 0.6679 1.2037 0.3542 0.0044 0.0153 0.2411 2.0518 8.5681 36.9384 0.2127 1105 708.33 0.000 0.527 0.000 0.000 0.002 0.020 0.911 0.673 0.012 0.368 0.016 0.082 0.150 0.367 0.223 0.397 0.923 0.494 0.714 0.014 0.106 0.000 0.3305 0.0425 0.8552 0.2205 0.0352 0.0244 0.0489 0.0115 1.4124 0.3637 1.8522 0.0007 0.0992 1.0169 0.9373 0.1965 0.0191 0.0284 0.1909 0.0390 3.6401 4.7060 0.2684 585 359.16 0.001 0.880 0.068 0.024 0.039 0.016 0.000 0.971 0.001 0.000 0.000 0.683 0.484 0.010 0.153 0.063 0.577 0.054 0.633 0.951 0.220 0.029 1.1433 0.4903 1.0012 0.2268 0.1050 0.0902 0.0121 1.5220 2.6041 0.7997 1.4827 0.0028 2.1526 3.2009 4.9068 1.2711 0.0895 0.0347 0.6466 4.1413 50.9405 17.7343 0.6410 195 329.26 0.001 0.432 0.239 0.292 0.053 0.200 0.561 0.038 0.076 0.001 0.154 0.518 0.002 0.006 0.001 0.005 0.290 0.358 0.615 0.133 0.001 0.023

Crisis period is defined as the years 19971998. Coefficients on interaction terms represent the difference in the effect of the firm characteristic on mutual fund stock ownership between crisis and non-crisis periods. Variable definitions are provided in Appendix A. Dependent variable: Aggregate proportional ownership of shares held of a Latin American stock by mutual fund managers in a calendar year.

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

231

The move into ADRs in response to the Asian and Russian crises is significant in Argentina and Chile. According to Ffrench-Davis and Larrain (2002), in September 1998 the Chilean Central Bank removed a non-interest bearing reserve requirement affecting the purchase of ADRs by foreigners. This could possibly explain the move into Chilean ADRs. Argentina is the only country where fund managers reduce their holdings of firms with high leverage in response to crises. The median leverage ratio of 27% in Argentina is the highest of the four markets, so the behavior among mutual funds appears consistent with a greater likelihood of financial distress among Argentinean firms. In contrast, fund managers increase their holdings of leveraged firms in Chile. Zervos (2004) indicates that Chilean firms can issue debt more cheaply abroad than locally, and the value of new Chilean international bond issues was greater than local bond issues for the latter half of the 1990s. Mutual fund preference toward leveraged firms in Chile could reflect the desire for increased monitoring associated with international debt, consistent with the findings of Harvey et al. (2004). The trade channel effect appears to be dominated by Brazil, since funds reduce their holdings of Russian export competitors. The reduction of holdings of large, cross-listed firms and firms with high current ratios in Mexico can reflect liquidity needs, although closed-end funds also reduce their holdings of large firms and firms with high current ratios. Table 8 investigates whether fund managers shift into or out of specific countries in response to the 19971998 crises relative to non-crisis years, controlling for firm attributes. Model 1 compares the effect of country on stock ownership (the omitted country is Brazil). Of the three remaining markets, Argentina and Mexico are preferred in the crisis
Table 8 Country effects on Latin American mutual fund stock ownership in crisis versus non-crisis periods Base model Tobit coeff. Argentina Chile Mexico Argentina * crisis Chile * crisis Mexico * crisis Crisis dummy Constant Percentage of uncensored obs. N Log likelihood 0.9819 1.2414 0.5368 1.0782 0.1945 2.2571 0.1571 16.7902 0.2844 2064 1708.93 p-value 0.058 0.002 0.236 0.042 0.628 0.000 0.531 0.000 Model (1): difference from non-crisis Coeff. p-value Model (2): difference from Brazil Coeff. p-value

0.9211 0.3516 2.1000

0.0507 0.2645 0.0000

2.0601 1.0469 2.7939

0.0006 0.0290 0.0000

Crisis period is defined as the years 19971998. Specification includes all firm characteristics listed in Appendix A. In model (1) the coefficients on the interaction terms represent the difference in the effect of the country on mutual fund stock ownership between crisis and non-crisis periods. In model (2) the coefficients on the interaction terms represent the difference in the effect of the country on mutual fund stock ownership relative to Brazil during the crisis period. Dependent variable: Aggregate proportional ownership of shares held of a Latin American stock by mutual fund managers in a calendar year.

232

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

relative to the non-crisis period. Chile, however, was not preferred during the crisis period. The strong trade linkage between Chile and Asia is a probable reason why fund managers did not prefer to invest in Chile. Chriszt (1999) indicates that Chiles trade exposure to Asia is over 30%, causing Chile to experience the adverse effects of the Asian crisis more than most of the other Latin American countries. Model 2 compares the effect of each of the three countries to Brazil on mutual fund stock ownership in response to the 19971998 crises. All three markets are preferred to Brazil during the period. Given that the Brazilian crisis was largely anticipated by the latter part of 1998, the preference away from Brazil is not surprising.

5. Conclusion In this study, I examine in Latin America from 1996 to 2001 the relation between mutual fund portfolio holdings of a firms stock and a firms characteristics. I investigate whether mutual fund stock holdings are influenced by specific firm attributes associated with incomplete information, financial health, competition, and governance. The results are consistent with studies conducted on other markets, suggesting that mutual fund preferences are relatively insensitive to geography. However, the main contribution of this study is that particular firm attributes exhibit different effects on mutual fund ownership between crisis and non-crisis periods. While most of the variables in the study influence mutual fund ownership, I find that firm characteristics associated with competitive exposure through trade and governance are among the key factors that determine differences in stock ownership between crisis and noncrisis periods. Fund managers reduce their holdings of firms that compete with Russian exports and increase their holdings of ADRs in response to crises. Since the move into ADRs is evident among closed-end funds that require less liquidity than open-end funds, this preference suggests that additional factors such as information asymmetry and governance concerns could influence the way fund managers respond to a crisis. Since the fundamental literature on contagion investigates trade linkages, the role of asymmetric information and corporate governance in portfolio choice in emerging markets merits further examination. Although the funds in the sample represent a relatively small number of decision-makers, their choices may represent the preferences of broader classes of institutional investors. However, whether there are differences in the behavior around financial crises across classes of institutions is ultimately an empirical question and an agenda for future work.

Acknowledgements This study is based on my dissertation written while at the University of Oregon. I thank my committee members Diane Del Guercio (Chair), Wayne Mikkelson, Woodrow Johnson, and Larry Singell for their valuable comments and advice. I also wish to thank Mark Stater, Paula Tkac, Emery Ventura, two anonymous referees, and seminar participants at Loyola Marymount University and the 2004 Financial Management Association Conference for their assistance and helpful suggestions.

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

233

Appendix A. Definition of firm characteristics and macroeconomic variables The source for firm financial data is Economatica, except for ADR program and S&P index. ADR program is obtained from the Bank of New York, and S&P index is obtained from Standard & Poors. Macroeconomic data is obtained from International Financial Statistics. Financial variables are measured in U.S. dollars. All data is taken at the year-end prior to the date of the portfolio holdings.

Firm characteristics Asymmetric information Total assets Total assets at year-end (natural log used in regressions) ADR Dummy = 1 if firm has an ADR program. This variable could also serve as a corporate governance variable due to the protection of minority shareholders through higher quality disclosure and the potential signaling of growth opportunities. S&P index Dummy = 1 if stock is a component in the S&P Latin American 40 index. The funds in the sample are benchmarked against various Latin American stock indexes, including Standard and Poors and Morgan Stanley Capital International. However, the major indexes use similar screening criteria to determine inclusion in the index. The main criteria generally include investability, liquidity, and market capitalization. The S&P Latin American 40 Index consists of firms specifically located in the four Latin American markets of interest. Financial health Return on assets Leverage Trade channels Asian exports Russian exports Governance Free float Net income / total assets at year-end (Short-term debt + long-term debt) / assets at year-end Dummy = 1 if three-digit NAIC code is an Asian export industry Dummy = 1 if three-digit NAIC code is a Russian export industry Percentage of firms not owned by blockholders, defined as shareholders who own 5% or more of the shares (Brazil and Chile only).

Additional control variables Current ratio Current assets / current liabilities at year-end Dividend yield (Sum of dividends per share paid during the year) / (year-end share price) Share turnover (Average dollar trading volume during the year) / (year-end market capitalization) (natural log used in regressions) Beta Covariance between monthly Latin American stock return and local market index return divided by standard deviation of local market index return measured over the prior 60 months Stock return Percentage year-end price change between year t and year t 1 adjusted for cash dividends Macroeconomic variables Interest rates Year-end deposit rate adjusted for local inflation Foreign exchange rate Percentage year-end change in national currency per U.S. dollar between year t and year t 1 adjusted for inflation (base year = 1993) GDP growth rate Percentage year-end change in the level of gross domestic product in local currency between year t and year t 1 adjusted for local inflation U.S. stock market return CRSP value-weighted market return between year t and year t 1 adjusted for U.S. inflation

234

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

Appendix B. Major exports from the Asian and Russian crises zones from Forbes (2004)
ASIAN CRISIS 11: Agriculture, forestry, fishing, and hunting 111: Crop production 1111: Oilseed and grain farming 1113: Fruit and tree nut farming 1119: Other crop farming 112: Animal production 1129: Other animal production 113: Forestry and logging 1132: Forest nurseries and gathering of forest products 114: Fishing, hunting and trapping 1141: Fishing 21: Mining 211: Oil and gas extraction 2111: Oil and gas extraction 212: Mining (except oil and gas) 2122: Metal ore mining 3133: Manufacturing 311: Food manufacturing 3112: Grain and oilseed milling 3113: Sugar and confectionary product manufacturing 3117: Seafood product preparation and packaging 3119: Other food manufacturing 313: Textile mills 3132: Fabric mills 314: Textile product mills 3149: Other textile product mills 315: Apparel manufacturing 3152: Cut and sew apparel manufacturing 316: Leather and allied product manufacturing 3161: Leather and hide tanning and finishing 3169: Other leather and allied product manufacturing 321: Wood product manufacturing 3212: Veneer, plywood, and engineered wood product manufacturing 325: Chemical manufacturing 3252: Resin, synthetic rubber, and artificial and synthetic fibers and filaments manufacturing 3259: Other chemical product and preparation manufacturing 326: Plastics and rubber products manufacturing 3261: Plastics product manufacturing 331: Primary metal manufacturing 3315: Foundries 332: Fabricated metal product manufacturing 3329: Other fabricated metal product manufacturing 334: Computer and electronic product manufacturing 3341: Computer and peripheral equipment manufacturing 3342: Communications equipment manufacturing 3343: Audio and video equipment manufacturing 3344: Semiconductor and other electronic component manufacturing 3345: Navigational, measuring, electromedical, and control instruments manufacturing

S. Elkinawy / Emerging Markets Review 6 (2005) 211237 335: Electrical equipment, appliance, and component manufacturing 3353: Electrical equipment manufacturing 336: Transportation equipment manufacturing 3364: Aerospace product and parts manufacturing 3365: Railroad rolling stock manufacturing 3366: Ship and boat building 339: Miscellaneous manufacturing 3399: Other miscellaneous manufacturing 42: Wholesale trade 421: Wholesale trade, durable goods 4219: Miscellaneous durable goods wholesalers RUSSIAN CRISIS 21: Mining 211: Oil and gas extraction 2111: Oil and gas extraction 3133: Manufacturing 331: Primary metal manufacturing 3312: Steel product manufacturing from purchased steel 3314: Nonferrous metal (except aluminum) production and processing 335: Electrical equipment, appliance, and component manufacturing 3353: Electrical equipment manufacturing

235

Exports are defined as four-digit SITC groups for which total exports from counties in the crisis regions are 25% or more of total world exports. NAIC codes are used to identify industries.

References
Aggarwal, R., Klapper, L., Wysocki, P.D., 2003. Portfolio Preferences of Foreign Institutional Investors. Working paper, Georgetown University, The World Bank, and Massachusetts Institute of Technology. Bazdresch, S. Werner, A.M., 2000. Contagion of international financial crises: the case of Mexico. Working paper, Banco de Mexico. Bekaert, G., Harvey, C.R., Ng, A., 2005. Market integration and contagion. Journal of Business 78, 39 69. Bennet, J.A., Sias, R.W., Starks, L.T., 2003. Greener pastures and the impact of dynamic institutional preferences. Review of Financial Studies 16, 1203 1238. Bikhchandani, S. Sharma, S., 2000. Herd behavior in financial markets: a review. Working paper, International Monetary Fund. Borensztein, E.R., Gelos R.G., 2001. A panic-prone pack? The behavior of emerging market mutual funds. Working paper, Center for Economic Studies and Ifo Institute for Economic Research and the International Monetary Fund. Choe, H., Kho, B.-C., Stulz, R.M., 1999. Do foreign investors destabilize stock markets? The Korean experience in 1997. Journal of Financial Economics 54, 227 264. Christoffersen, S., Geczy, C., Musto, D., Reed, A., 2003. The limits to dividend arbitrage: implications for crossborder investment. Working paper, McGill University, University of Pennsylvania, and the University of North Carolina. Chriszt, M., 1999. Comments on the outlook for Latin America. Federal Reserve Bank of Atlanta Latin America Research Group. bhttp://www.frbatlanta.org/N. Coffee, J.C., 2002. Racing towards the top? The impact of cross-listings and stock market competition on international corporate governance. Columbia Law Review 102, 1757 1831. Covrig, V., Lau, S.T., Ng, L., 2001. Do domestic and foreign fund managers have similar preferences for stock characteristics? A cross-country analysis. Working paper, Nanyang Technological University and University of Wisconsin-Milwaukee.

236

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

Dahlquist, M., Robertsson, G., 2001. Direct foreign ownership, institutional investors, and firm characteristics. Journal of Financial Economics 59, 413 440. Davis, E.P., Steil, B., 2001. Institutional Investors. The MIT Press, Cambridge, MA. Del Guercio, D., 1996. The distorting effect of the prudent-man laws on institutional equity investments. Journal of Financial Economics 40, 31 62. Doidge, C., Karolyi, G.A., Stulz, R.M., 2004. Why are foreign firms listed in the U.S. worth more? Journal of Financial Economics 71, 205 238. Falkenstein, E.G., 1996. Preferences for stock characteristics as revealed by mutual fund portfolio holdings. Journal of Finance 51, 111 135. Ffrench-Davis, R., Larrain, G., 2002. How optimal are the extremes? Latin American exchange rate policies during the Asian crisis. United Nations University, Discussion Paper No. 2002/18. Forbes, K.J., 2004. The Asian flu and Russian virus: the international transmission of crises in firm-level data. Journal of International Economics 63, 59 92. Froot, K.A., OConnell, P.G., Seasholes, M.S., 2001. The portfolio flows of international investors. Journal of Financial Economics 59, 151 193. Gaviria, A., 2002. Assessing the effects of corruption and crime on firm performance: evidence from Latin America. Emerging Markets Review 3, 245 268. Gompers, P.A., Metrick, A., 2001. Institutional investors and equity prices. Quarterly Journal of Economics 116, 229 259. Greene, W., 2003. Fixed effects and bias due to the incidental parameters problem in the Tobit model. Working paper, Department of Economics, Stern School of Business, New York University. Grinblatt, M., Keloharju, M., 2001. How distance, language, and culture influence stockholdings and trades. Journal of Finance 56, 1053 1073. Harvey, C.R., Lins, K.V., Roper, A.H., 2004. The effect of capital structure when expected agency costs are extreme. Journal of Financial Economics 74, 3 30. Holderness, C.G., 2003. A survey of blockholders and corporate control. Federal Reserve Bank of New York Policy Review 9, 51 64. Investment Companies Yearbook, 19962001 (CDA/Wiesenberger, Rockville, MD). Jensen, M.C., 1986. Agency costs of free cash flow, corporate finance, and takeovers. American Economic Review 76, 323 329. Johnson, S., Boone, P., Breach, A., Friedman, E., 2000. Corporate governance in the Asian financial crisis. Journal of Financial Economics 58, 141 186. Kaminsky, G.L., Lyons, R.K., Schmukler, S.L., 2000. Economic fragility, liquidity, and risk: the behavior of mutual funds during crises. Working paper, George Washington University, UC Berkeley and NBER, and the World Bank. Kaminsky, G.L., Lyons, R.K., Schmukler, S.L., 2001a. Managers, investors, and crises: mutual fund strategies in emerging markets. Working paper, George Washington University, UC Berkeley and NBER, and the World Bank. Kaminsky, G.L., Lyons, R.K., Schmukler, S.L., 2001b. Mutual fund investment in emerging markets: an overview. Working paper, George Washington University, UC Berkeley and NBER, and the World Bank. Kang, J.K., Stulz, R.M., 1997. Why is there a home bias? An analysis of foreign portfolio equity ownership in Japan. Journal of Financial Economics 46, 3 28. Kim, W., Wei, S.-J., 2002. Foreign portfolio investors before and during a crisis. Journal of International Economics 56, 77 96. Klapper, L.F., Love, I., 2002. Corporate governance, investor protection, and performance in emerging markets. Working paper, World Bank. Lang, M.H., Lins, K.V., Miller, D., 2003. ADRs, analysts, and accuracy: does cross listing in the U.S. improve a firms information environment and increase market value? Journal of Accounting Research 41, 317 345. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R., 2000. Investor protection and corporate governance. Journal of Financial Economics 58, 3 27. McDonald, J.F., Moffitt, R.A., 1980. The uses of Tobit analysis. Review of Economics and Statistics 62, 318 321.

S. Elkinawy / Emerging Markets Review 6 (2005) 211237

237

Merton, R.C., 1987. A simple model of capital market equilibrium with incomplete information. Journal of Finance 42, 483 510. Mitton, T., 2002. A cross-firm analysis of the impact of corporate governance on the East Asian financial crisis. Journal of Financial Economics 64, 215 241. Reese, W.A., Weisbach, M.S., 2002. Protection of minority shareholder interests, cross-listings in the United States, and subsequent equity offerings. Journal of Financial Economics 66, 65 104. Schiffer, M., Weder, B., 2001. Firm size and the business environment: worldwide survey results. International Finance Corporation Discussion Paper No. 43. Zervos, S., 2004. The transactions costs of primary market issuance: the case of Brazil, Chile, and Mexico. World Bank Policy Research Working Paper 3424.