The effect of disaggregated country risk on the South African equity portfolio returns under changing market conditions.

Abstract

Globalization has resulted in the rapid increase of international trade and international mobility of financial capital. Capital inflows into South Africa date back to the early 1990s and these inflows continue to grow. With increased investments into the country, investors can diversify some local risks. Still, they also become exposed to the different components of country risk (political, financial, and economic risk). However, depending on the investor's risk appetite, country risks may encourage or discourage foreign portfolio investments. This study examined the effects of disaggregated country risk on South African equity portfolio returns under changing market conditions. Additionally, this study compared how South African domestic and foreign equity portfolios respond to changes in country risk components under bearish and bullish market conditions. A Markov switching approach was employed to analyse monthly data of 19 equity portfolios for the sample period spanning from January 2000 to December 2019. The results suggested that domestic and foreign portfolios spent more time in downward trends. Moreover, the effects of country risk components depend on market conditions for both domestic and foreign portfolios. In both cases, the impact of country risk components is more significant in bull than in bear market conditions. Essentially, economic and financial risk had a more substantial impact on domestic portfolios, whereas political risk was more significant on foreign portfolios. In this way, political risk cannot be diversified through investing in foreign portfolios. These findings have crucial implications as they indicate that it is vital to maintain a stable economic, financial and political environment to encourage sustainable portfolio investment.