Empirical perspectives on national index funds

Closed-end national index funds (NIFs of country funds) invest primarily in the stocks of the originating countries, such as Brazil, India, and the Republic of Korea. They are typically traded in the organized exchanges of industrial countries, such as the United States and the United Kingdom. Although NIFs have not raised large amounts of external funds, recently they have expanded rapidly. In a companion paper ("The Pricing of Country Funds and Their Role in Capital Mobilization for Emerging Economies,"WPS 1058), the authors develop a theoretical model to compare the pricing of country funds in the reference markets (say the United States) with the pricing of the underlying component assets (or net asset valuation) in the originating securities market under various assumptions about market structure. In this paper, they empirically investigate the hypotheses that emerge from the model. They first analyze country fund pricing and associated premia, or discounts, and then explore the issue of diversification services provided by NIFs from emerging markets. The emphasis on emerging markets is important as many markets are otherwise closed to foreign investors. They compare results across emerging and industrial markets and, where appropriate, over different subperiods. Their evidence suggests that U.S. investors could benefit significantly in diversification that involves NIFs, particularly funds originating from countries to whose local markets they have limited access. The authors investigate the pricing of NIFs, testing their principal theoretical predictions about the relative significance of the home market, host market, and global closed-end fund factors. They analyze initial (public-offering literature) and after-market returns, and explain the behavior of fund premia/discounts. The evidence shows that variables that proxy the degree of access and substitution effects show up as significant determinants of country fund premia/discounts. The empirical study supports their theory about the welfare implication for emerging economies that originate country funds. The model suggests that country funds can improve pricing efficiency in local capital markets and promote local capital mobilization by firms at more favorable terms (lower costs of capital).