Brexit and global equity fund capital reallocation

The June 2016 Brexit referendum has increased uncertainty and decreased the market correlation between the U.K. and other countries. In this study, we investigate an essential consequence of such changes (i.e., post-referendum capital flows induced by global funds strategically adjusting their portfolio allocations across countries) and attempt to identify the functioning channel underlying these effects, considering that uncertainty and market correlation are two fundamental but contradictory factors in portfolio decisions. Using a difference-in-differences specification, we find that the relative portfolio shares allocated to the U.K., compared with European countries, decrease significantly after referendum, with the magnitude of reduction depending on fund-specific characteristics. These patterns are inapplicable to adjustments across Europe and other regions. Furthermore, we prove that it is the uncertainty associated with referendum rather than the diminished market correlation that predominantly drives the portfolio adjustment effect of Brexit.