Better investing in Europe
The dominoes started falling in 2008, the year when the largest investment banks in the US either went bankrupt or were sold at fire-sale prices to other banks. This pushed the global financial markets to go into a free fall. Not long after the crisis hit European shores, where it quickly transformed into a debt crisis. Soon austerity measures became commonplace while, at the same time, national economies struggled to grow. ‘The problem with Europe was simple,’ says EURO-INVEST Lead Researcher K. Ozgur Demirtas. ‘European countries each had their own staggering national debts, there were huge budget deficits, and shrinking economies did not supply enough money to the system.’ According to Demirtas, the answer to this problem was new investments into the Eurozone. Unfortunately, things weren’t that easy. ‘To pay their national debts, governments must cut spending,’ he explains. ‘This results in sharp cuts to private sector growth which, in turn, creates a lack of confidence of investors in the Eurozone and instead encourages them to invest in emerging markets.’ It is this vicious loop that motivated Demirtas to investigate the practice of investing in European and emerging economies for different investment horizons and subsample periods. A vicious loop The project first looked at the fact that as European markets tumbled, many emerging markets were excelling and how investors penalised companies per the country they operated in. Thus, for example, in theory, if Italy had a budget deficit, high-debt-to-income ratio and growth issues, investment in the country would dry up and Italian companies would be penalised. However, if this was the case, many public companies would not get the necessary investor attention they deserved simply because of the performance of the region they happened to be located in. ‘Within this framework, we undertook the task of examining all European public companies against world and emerging market indices,’ says Demirtas. ‘Our hypothesis was that when state-of-the-art techniques such as Almost Stochastic Dominance (ASD) and Almost Mean-Variance rules are applied, investors’ confidence in emerging economies may end up being groundless.’ The wrong thing to do What Demirtas discovered was that, at short investment horizons, none of the examined indices were dominant. However, at a five-year investment horizon, emerging market indices dominated all others, making it seem that an index investor would be better off investing in these indices rather than developed market or EMU indices. However, the story doesn’t stop there. After examining over 144 million daily observations of 64,051 stocks listed in 51 countries, researchers found that a significant 10.1 % of the traded securities dominate the developed market index while 7.8 % in the emerging market index. Based on these findings, the conclusion was that by excessively penalising certain securities in the Eurozone during the crisis period, investor behaviour actually helped fuel the vicious loop. ‘Indeed, there are European securities with certain characteristics that continued to dominate alternative investments even after the crisis period,’ says Demirtas. ‘This may very well show that unloading EU or EMU securities during the crisis period was the wrong thing to do and only helped to self-fulfil the prophecy of the European crisis.
Keywords
EURO-INVEST, debt crisis, financial crisis, European market, EU securities, EMU securities