U.S. mutual funds suffer measurable losses when export controls target Chinese firms, even though the funds hold only domestic stocks, according to a new Federal Reserve Bank of New York staff report published October 1. The research documents how geoeconomic risk—the threat that firms lose value when countries use economic tools for geopolitical goals—reaches American investors through global supply chains. Funds exposed to newly sanctioned Chinese customers experience a 22-basis-point drop in monthly returns for every one standard deviation increase in exposure, equivalent to 2.5 percent of portfolio assets.

The report examined more than 5,000 U.S. domestic equity mutual funds from 2010 to 2023, tracking their holdings of American companies that supply Chinese customers added to export control lists by the Bureau of Industry and Security. On average, these funds invest 20.3 percent of their assets in U.S. firms with at least one Chinese customer. Science and technology funds show the highest concentration, with 43.3 percent of portfolios tied to firms connected to Chinese customers. Within these China-linked holdings, suppliers to newly targeted Chinese entities account for 8.4 percent of fund assets. When export controls are announced, stocks of affected U.S. suppliers drop by a cumulative 3.6 percent, with most of the decline happening in the first five trading days. Passive funds suffer steeper losses than active funds—31 basis points versus 22 basis points for the same exposure level—and passive funds also see outflows of about 0.35 percent of assets in the following month.

The authors find that active fund managers respond by selling not just the directly affected suppliers but also other U.S. firms linked to China that weren't hit by the current announcement. This selling continues three months after controls are imposed, suggesting managers don't view the price drop as a temporary shock. The research also shows that specialist managers and higher-fee funds experience smaller performance declines after export control shocks, while traditional market-timing and stock-picking skills don't predict better outcomes. "The management of geoeconomic risk might require the ability to map potential policy shocks onto firms' positions in global value chains," the report states.

Investors appear to demand compensation for bearing geoeconomic risk, the report concludes. A portfolio that buys previously exposed firms and shorts unexposed ones earns roughly 1 percent per month in abnormal returns after adjusting for standard risk factors, indicating the market treats geoeconomic exposure as a priced risk rather than a one-time news event. The authors explain that geoeconomic shocks are hard to diversify away because they can hit multiple domestic stocks through a shared foreign exposure, particularly as export controls have been used frequently in the U.S.-China technological rivalry since 2014 in sectors like semiconductors, telecommunications, artificial intelligence, and advanced computing. As economic policy ties more closely to national security, the report warns, the relevant question for investors isn't only where a stock is listed but where the firm earns revenues and how exposed those relationships are to geopolitical policy shocks. Diversification across domestic stocks may not fully protect portfolios when many firms share similar global exposures, making it critical for investors to understand the international linkages of the companies they hold.