Teflon Capitalism: Geopolitical Risk and Investment Funds

Abstract

Why do stock markets appear resilient to geopolitical risk? Using firm-level measures of geopolitical risk exposure and data on investment funds’ holdings, we show how funds help swiftly restore valuations compressed during bouts of heightened geopolitical risk. More intense geopolitical shocks strengthen this stabilizing role. Declines in valuations of exposed but otherwise sound firms raise expected returns, attracting funds to acquire these assets at depressed prices, consistent with a search for yield mechanism. This behavior is more pronounced among funds with greater risk-taking capacity and weaker past performance. Funds’ tilt toward exposed stocks increases portfolio concentration, partly offset by higher cash buffers. In contrast, ultimate investors withdraw from exposed funds. The results are not driven by any particular industry—including defense or dual-use production—and are robust to a rich set of controls, fixed effects, and placebo tests. Show more