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

3.2: Performance attribution (conditional) 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 stocks with different levels of emerging market exposure, depending on the spread in return of emerging and developed market equity. We define a 'bull (or bear) market' condition as calendar year quarters when the difference in emerging and developed market equity is positive (or negative). The performance attribution is conducted separately for both bull and bear market conditions. Second, we analyse the performance attribution of Developed market indices to stocks with different levels of local market exposure, depending on the spread in return of local and foreign market equity. We define a 'bull (or bear) market' condition as calendar year quarters when the difference in local and foreign market equity is positive (or negative). The performance attribution is conducted separately for both bull and bear market conditions.

3.2.1 Conditional analysis (bull and bear market)- Performance attribution of emerging market exposure to the performance of Developed market indices

In this section we analyse the performance attribution of emerging market exposure to the performance of developed market indices conditioned on the performance of emerging market equity relative to developed market equity. We consider MSCI Emerging and MSCI World as the benchmark for emerging and developed market equity, respectively. In the table below we note that during bull markets, when the return of emerging market equity is higher than that of developed market equity, stocks with high exposure to emerging markets contributed more (4.58%) than stocks with low exposure to emerging markets (3.42%). Similarly, during bear markets, when the return on emerging markets was lower than developed markets, stocks with low emerging market exposure contributed more (0.80%) to the performance of the S&P 500 than stocks with high exposure to emerging markets (-1.25%).

Table 14: Return contribution to S&P 500 of stocks with varying Emerging Market exposure (Conditional Analysis based on Emerging vs. Developed market return spread): The table below reports the breakdown of the annualised excess return of the S&P 500 into the performance of three portfolios formed by sorting stocks based on their sales exposure to emerging markets. We report performance attribution separately for bull and bear markets, wherein bull (or bear) market is defined as calendar year quarters where the spread between emerging and developed market returns is positive (or negative). The benchmarks for emerging and developed markets are MSCI Emerging and MSCI World, respectively. To form portfolios, we sort stocks by their emerging markets sales exposures. We then select the top stocks up to 33% of cumulative market cap (High), and the bottom stocks up to 33% cumulative market cap (Low), and form cap-weighted high and low exposure portfolios based on these sorts. Stocks which are not included in either extreme portfolio form the medium portfolio (Mid). The portfolios are formed at the end of June every year, using geographic segmentation data for the previous fiscal year. The statistics are based on daily total return series (with dividends reinvested) in USD. The portfolio constituents are weighted by their total market capitalisation in (USD) at the end of June every year. The figures for High and Low portfolios are highlighted in bold. For performance attribution, we use OLS regression, wherein the dependent variable is the excess return on the S&P 500 and independent variables are excess returns on High, Mid and Low portfolios. All returns are in excess of the risk-free rate. The risk-free rate in US Dollars is measured using the return on the Secondary Market US Treasury Bills (3M). The source of geographic segmentation data is DataStream. In the event that the excess return on the index is negative, we do not calculate % contribution as it gives less meaningful figure. Such figures are replaced by NA.

High

Mid

Low

Unexplained

S&P 500

Contr.

% Contr.

Contr.

% Contr.

Contr.

% Contr.

Contr.

% Contr.

4.58% 38.88%

3.42% 29.04%

Bull Market

11.77%

3.34% 28.38%

0.44% 3.70%

-1.25% NA

0.80% - NA

Bear Market

-0.77%

-0.26% NA

-0.06% NA

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An EDHEC-Risk Institute Publication