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

Conclusions

In this paper we analyse the application of geographic segmentation data. First, we analyse the sales exposure of companies in the three broad Developed market indices (S&P 500, STOXX Europe 600 and FTSE Developed Asia Pacific) to four geographic regions (the Americas, Europe, Asia & Pacific and Africa & Middle East) and to developed and emerging markets. We note that for each of the indices, a significant portion of their sales come from non-domestic regions (21% to 45% in FY 2012). Also, the proportion of sales coming from non-domestic regions has increased over the 10-year period FY2003 to FY2012, except for companies in the FTSE Developed Asia Pacific index. Among the three indices, the companies in STOXX Europe have maximum exposure to non-domestic regions (45% in FY2012). The breakdown of sales into developed and emerging markets tells us that the exposure of companies in the three developed market indices to emerging markets is significant. The companies in the STOXX Europe 600 have maximum exposure to emerging markets (45%). The exposure to emerging the markets has also increased over time, with the highest increase for companies in the STOXX Europe 600 (increase of 12%). We also extend this analysis to two narrow indices (FTSE 100 and STOXX Europe 50) and notice similar trends in terms of their exposure to non-domestic regions and emerging markets. Second, we analyse the effects of such exposure on the performance of these indices by distinguishing between companies with varying degrees of underlying economic exposure (in terms of geographic sales breakdown), and attribute index performance to these different geographic exposure categories.

We note that there are certain years when the difference in contribution of high and low "local" market exposure portfolios to the performance of indices is large. For example, during July 2004-June 2005, the contribution of high and low local-market- exposure portfolios to the performance of the S&P 500 is 4.29% and -1.27%, respectively. Similarly, there are years when the contribution of high and low emerging market portfolios to the performance of the index is large. For example, in July 2004-June 2005, the contribution of high and low local-market-exposure portfolios to the performance of the S&P 500 is -0.70% and 5.04%, respectively. We also extend this analysis to performance attribution conditioned upon on different market conditions. We note that when emerging markets perform better than developed markets, the stocks with high exposure to emerging markets contribute more to the performance of the index than stocks with low exposure to emerging markets. Likewise, when emerging markets perform worse than developed market equity, the stocks with higher exposure to emerging markets contribute less to the performance of the developed market indices than stocks with lower exposure to the emerging markets. Also, we note that when local market equity performs better (worse) than foreign market equity, the stocks with high exposure to local markets contribute more (less) to the performance of the index than stocks with low exposure to the local market. Similarly, when the local market performs worse than the foreign market, the stocks with high exposure to local markets contribute less to the performance of indices than stocks with lower exposure to local market.

To summarise, the need to report the geographic exposure of equity indices

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An EDHEC-Risk Institute Publication