How do fund managers react to geopolitical shocks?
Not well, I would say, after reading an analysis of US mutual fund managers by Matteo Crosignani and his collaborators. The problem is not so much that active managers can’t predict geopolitical shocks like the export bans of US goods to China investigated in this study, but how they deal with the fallout from the shock.
Of course, it is impossible to forecast if and when the US government will impose export bans on US goods to China for national security reasons. But once that happens, the stocks of companies that are affected by these export bans drop immediately. Just think of telecom hardware suppliers in the wake of the ban on Huawei and ZTE in the US.
In the months after a Chinese company is put on the ‘US entity list’ (thus proscribing US businesses from dealing with the company), the returns of affected US equity funds decline, and the volatility of the funds increases.
Impact of US export ban on US equity funds
Source: Crosignani et al. (2025)
Fund managers react to such a shock by reducing the positions they hold in the affected companies or selling them altogether. This increases portfolio concentration and thus volatility, unless the freed-up cash is reinvested in diversifying new portfolio holdings.
But rather than investing the money into stocks that diversify the now more concentrated portfolio, fund managers are trying to play catch-up with their benchmark. Hence, they tend to invest some of the cash they got from selling the affected US stocks in lottery stocks in the hope of generating ‘alpha’ in the next couple of months that can make up for the losses. As the chart below shows, the positions of lottery stocks in the portfolio of affected funds increase by about 4% relative to before the shock.
The result is that a fund that has been hit by a geopolitical shock tends to become more concentrated, more volatile and riskier in the months after the event. Not because of the increased risks in markets or individual stocks, but because of the desperation of fund managers.
Change in lottery stock holdings after a geopolitical shock
Source: Crosignani et al. (2025)
Doesn't surprise me in the least.
Russell Napier has been arguing for years that western firms should (begin to) hire managers from EM because they are much more accustomed to working in / working around shocks. And i wonder if we would have seen older managers perform better in the above study if it had made that distinction.
Just in, related, in so far that this substack discusses studies, and economics studies in particular, from the always interesting The Nature-Nurture-Nietzsche Newsletter by Steve Stewart Williams, this:
Should We Trust Social Science Research?
I.e. Does it replicate?
'As a reader of The Nature-Nurture-Nietzsche Newsletter, you’ve no doubt heard of the replication crisis: the finding that only around half of studies in the social sciences replicate. Well, here’s a question for you: Is that finding itself replicable?
A massive new study by Andrew Tyner and colleagues, published in the journal Nature, addresses that thorny question, and comes to a strong conclusion: Yes.'
Economics fares worst but don't worry: psychology, business, political sciences and last but never least sociology also compete for last place.
https://www.stevestewartwilliams.com/p/should-we-trust-social-science-research?utm_source=post-email-title&publication_id=318964&post_id=192915809&utm_campaign=email-post-title&isFreemail=true&r=6mos7&triedRedirect=true&utm_medium=email