Economic policy uncertainty and institutional investment returns: The case of New Zealand

This study introduces a monthly news-based economic policy uncertainty index for New Zealand (NZ EPU) and examines the pricing implications of NZ EPU on a large sample of institutional investors. We find that NZ EPU is a priced and an undiversifiable risk factor that commands a statistically and economically significant risk premium of 6.23% on annual basis in the cross-section of managed fund returns. Interestingly, despite the fact that about 70% of the funds in our sample adopt a global focus, our tests show that local uncertainty plays a more dominant role as a driver of institutional investment returns compared to global policy uncertainty. We show that funds with lower (higher) sensitivity to NZ EPU index generate significantly higher (lower) subsequent excess returns, even after controlling for the well-established systematic risk factors and fund level determinants. Further analysis suggests that NZ EPU betas are highly persistent and can predict short- and long-term returns up to 12 months, implying that active fund managers can devise an active timing strategy by tracking changes in the NZ EPU index. Our findings present important implications for policy makers and investors as the proposed NZ EPU index is able to capture both global and local shocks, while it aligns well with the overall trends in the business outlook surveys.