Accounting for Geographic Exposure in Performance and Risk Reporting for Equity Portfolios

Accounting for Geographic Exposure in Performance and Risk Reporting for Equity Portfolios — March 2015

Section 3: Application to Performance Attribution

attribution analysis, as sorting stocks based on different levels of geographic exposure into three portfolios leads to few stocks in each portfolio (such as in the case of the STOXX Europe 50), leading to less meaningful results. 3.1: Contribution of Emerging/ Local Markets Exposure to the Performance of Developed Market Indices In this section first we analyse the performance attribution of developed market indices to portfolios formed by sorting stocks based on their level of sales in emerging markets and local markets. We analyse the performance attribution for each of the years starting July 2004 till June 2014. 3.1.1: Contribution of emerging markets exposure to the performance of Developed market indices In this sub-section, we analyse the performance attribution of developed market indices to portfolios formed by sorting stocks based on their level of sales in emerging markets. Table 8 below reports the performance attribution for the S&P 500 index. We note that there are years when the contribution of high and low emerging market exposure portfolios contributed similarly to the excess return of the S&P 500 index (e.g. July 2005-June 2006), but there are years when the difference in contribution is noticeable. For example, in July 2004-June 2005, the contribution of the high emerging market exposure portfolio was -0.70%, while that of the low emerging market exposure portfolio was 5.04%. Also, in July 2007-June 2008, the negative contribution of the high

where, R i,t are returns on the index and the risk-free rate, respectively. R P 1, t , R P 2, t and R P 3, t are returns on the top portfolio, middle portfolio and bottom portfolio, respectively. and R f,t

The contribution of a portfolio to the excess return of the index is computed as

where, C i

is the contribution of portfolio i

and i ∈ {1, 2, 3}.

The unexplained performance is the difference in the excess returns of the index and the sum of the contributions from each of the portfolios. First, in Section 3.1, we report yearly performance attribution of the three broad Developed market indices to the portfolios formed on the basis of exposure of stocks to emerging markets (local market) sales. Next, in Section 3.2, we report conditional performance attribution of the three indices to the portfolios formed on the basis of exposure of stocks to emerging markets (local markets) sales. Here, we analyse performance attribution based on two different market conditions: First, performance attribution to stocks with different levels of emerging market exposure, depending on the spread in returns of emerging and developed market equity. Second, performance attribution to stocks having different levels of local market exposure, depending on the spread in returns of local and foreign market equity.

Note that we do not consider the FTSE 100 and STOXX Europe 50 for performance

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An EDHEC-Risk Institute Publication