The Effect of Disaggregated Country Risk on the Returns of the South African Exchange Traded Fund Market

In recent years, investors have drifted towards investments in emerging markets with better risk-return trade-offs, however, these markets are generally characterized by high political, financial, and economic risk. Given the rising popularity of Exchange Traded Funds (ETFs), the objective of this study is to investigate the effect of disaggregated country risk on the returns of the South African ETF market. The study utilises a sample of South African ETFs which are segregated based on their benchmarking strategy (that is, purely domestic benchmarks or international benchmarks), and the sample period ranges from the inception of the first ETF in the respective market till December 2019. A linear and non-linear Autoregressive Distributed Lag (ARDL) approach is used to explore the long- and short-run effects; however, the findings of this study suggest that country risk shocks have significant asymmetric effects on returns. Further analysis suggests that, in the long-run, ETFs with domestic benchmarks are most sensitive to political risk decreases whilst ETFs with international benchmarks are most sensitive to political risk increases. In the short-run, ETFs with domestic benchmarks are only influenced by political and financial shocks whilst all country risk components impact ETFs with international benchmarks. Overall, these findings can assist investors, rating agencies, multi-national enterprises, and policymakers in understanding the effects of country risk components on ETF markets.