Repricing of risk and EME assets: the behaviour of Irish-domiciled funds during the COVID-19 crisis

In 2020Q1, emerging market economies (EMEs) experienced significant outflows of portfolio investment capital. Irish-domiciled funds contributed to these portfolio outflows through sales of EME securities in response to heightened redemptions. Consistent with previous evidence around the sensitivity of Irish-resident fund flows to changes in global risk appetite, the retrenchment by Irish-domiciled funds in 2020Q1 was greater for debt, rather than equity, securities. Relative to their initial positions, the retrenchment was bigger for hedge funds, suggesting leverage may have acted as an amplifier of asset sales. Overall, though, Irish-domiciled funds also retrenched by less than might have been expected, given the historical relationship between measures of global risk aversion and fund flows to EMEs. In part, this may be due to the fact that, in the face of large redemptions, Irish funds also sold more liquid advanced economy securities. This points to potential common creditor effects acting as a transmission channel of shocks. The analysis also finds that EME countries with stronger fundamentals were somewhat cushioned from the retrenchment. Finally, valuation effects were strongest vis-a-vis EMEs with more flexible exchange rate regimes, suggesting a major role for currency depreciations in driving the observed reduction in positions.