In new research, EDHEC-Risk Institute proposes a different reporting approach to better assess the real risks and performance of a portfolio

Written on 07 April 2015.

This research was conducted with the support of CACEIS as part of EDHEC-Risk Institute’s research chair on “New Frontiers in Risk Assessment and Performance Reporting”.

This study finds that, for a number of stocks, their official nationality does not match their real economic exposure as represented by the company’s distribution of sales. A dominant practice in the search for international diversification of equity portfolios is to classify stocks according to their place of listing, incorporation or headquarters. However, such a practice is questionable within the context of a globalised marketplace where a company's operations are typically not restricted to any single country.

This study uses geographic segmentation sales data introduced by the new international accounting rules that preside over the reporting activities of listed companies within the context of assessing geographic equity risk exposure. This study clearly shows that, in developed market indices, the percentage of company sales generated outside the official region of the index is significant and has increased in recent years. For example, the cap-weighted non-US exposure of the S&P 500 and the non-European exposure of the STOXX Europe 600 between June 2004 and June 2013 increased from 30% to 39% and from 41% to 53%, respectively. This indicates, for the STOXX Europe 600 for example, this indicates that the index is predominantly non-European.

These real economic exposures essentially influence variations in index performance. A clear separation between stocks actually exposed to the nationality of the index and those that are not allows us to distinguish the real differences in performance between these groups, naturally with conditional performance that is more or less pronounced vis-à-vis the market that they officially supposed represent or, conversely, the market that matches their real geographical exposure.

In this study, EDHEC-Risk Institute ultimately shows that the assessment of the geographic exposure and diversification of portfolios presents an incorrect view when simply using measures such as a stock’s place of listing, place of incorporation or, more generally, the nationality of the indices it belongs to. Consequently, it may transpire that the geographical diversification of equity portfolios, based on such incorrect assessments of economic exposure, turns out to be vastly sub-optimal.

In this perspective, this EDHEC-Risk Institute initiative, supported by CACEIS, allows investors to take account of the real geographic risks of their portfolios when making strategic or tactical asset allocation decisions. It would indeed be disappointing for asset managers to compromise their asset allocation policy by poorly evaluating the geographic reality of their portfolio or benchmark.

A copy of “Accounting for Geographic Exposure in Performance and Risk Reporting for Equity Portfolios” can be downloaded via the following link:

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

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