Granular Portfolios, Expectations, and International Capital Flows

We identify a novel channel of international financial contagion driven by investor expectations. Using a unique dataset linking investors’ cross-country GDP growth expectations to their equity mutual fund investments and to funds’ country allocations, we show that inflows into mutual funds respond strongly to fund-level expected growth, whereas funds’ country allocations react only weakly to country-specific expectations. This asymmetry generates co-ownership spillovers: negative expectations about one country propagate mechanically to other countries held in the same funds, even in the absence of changes in the country's own expected fundamentals. We develop a portfolio choice model with delegated investment and portfolio stickiness to rationalize this pattern. Because country weights in global portfolios are highly granular, these spillovers are quantitatively important, accounting for about 80% of expectation-driven capital flow reallocation. Small countries are disproportionately exposed to these spillovers, while large countries are their main sources.