Local Factors and Return Chasing: A New Phase in Emerging Equity Markets

Does the global financial cycle still dominate capital flows to emerging markets? Lever-aging granular investor-level data, this paper examines a structural shift in the drivers of global equity flows. Using a dynamic factor model to decompose flows into global (push) and country-specific (pull) components, we show that while global factors historically dominated, local factors have emerged as the primary driver of capital allocation, particularly in the post-COVID period. Local projections reveal the mechanism behind this shift as a resurgence of active return chasing: investors have become increasingly sensitive to local excess returns, re-coupling flows to domestic price discovery. We trace this shift to greater portfolio concentration among emerging markets within investors and improved macroeconomic resilience in emerging market economies. Our findings suggest that global investors increasingly differentiate across emerging markets based on local return factors rather than responding uniformly to common global factors. This deepening sensitivity to domestic conditions may expand the scope for domestic policy frameworks and, in turn, enhance the developmental benefits of financial integration by better aligning capital with local investment opportunities in emerging and developing economies.