Ladekarl and Zervos look at the investment allocation process employed by portfolio investors in emerging markets. In particular, they examine the first of a two-stage decision process: First, investors create a subset of investable countries to be analyzed later in further detail; second, they weigh expected returns versus risk and subsequently allocate their funds. The authors hypothesize that the determination of whether a country is investable or not is influenced by a number of factors, especially related to size, quality of housekeeping, (macroeconomic policies, political economy, local financial markets, corporate governance, and so on), and efficiency of plumbing (legal and regulatory framework, custody, clearing and settlement, taxes, and so on). By interviewing many types of these investors in both the United States and the United Kingdom, the authors delve into their decision-making processes as well as attempt to uncover the factors they indicate matter most in defining the investable universe. They determine the relative importance of such housekeeping and plumbing factors while highlighting the role of external issues, such as index benchmarking and U.S. foreign policy. The authors recognize from the outset that the most profound effects on investment flows, or the required minimum expected returns, arise from improvements or deteriorations in macroeconomic policies. However, at the margin, improvements can be made in country policies that will, for a given macroeconomic situation, improve the ability of a country to attract international investment flows.This paper - a product of the Financial Sector Operations and Policy Department - is part of a larger effort in the department to study the functioning of pension funds and other institutional investors
