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

Executive Summary

performance attribution, where we attribute the yearly performance of the developed market index to the performance of portfolios which have varied levels of exposure to emerging markets or local markets (official market). Here, we consider only three broad market indices (S&P 500, STOXX Europe 600 & FTSE Developed Asia Pacific) and not narrow indices such as FTSE 100 and STOXX Europe 50, as sorting stocks based on varied levels of geographic exposure leads to portfolios having few stocks, which can lead to less meaningful results. We also analyse performance attribution of indices during different market conditions: performance attribution depending on (1) difference in return of emerging and developed market equity and (2) difference in return of local and foreign market equity. Data and Methodology We report the geographic exposure of the index constituents at the end of June every year over ten years (2004 to 2013). For the index constituents as of June t , we consider sales for fiscal year t-1 in order to avoid look-ahead bias. The source of geographic segmentation data is DataStream (Worldscope), supplemented by Bloomberg. It provides geographic breakdown of sales as reported by companies. We report the geographic exposure of indices to four regions (Americas, Europe, Middle East & Africa and Asia & Pacific) as well as to developed and emerging markets. To determine countries that constitute the above mentioned four regions, we rely on the United Nations Statistics Division (UNSD), 1 which groups individual countries (economies) into sub-regions, further aggregated into

A standard practice in reporting geographic exposure of equity portfolios is to report breakdown of portfolio constituents by country or region, which are assigned to a stock based on its place of listing, incorporation or headquarters. However, the practice is questionable in the context of a globalised marketplace where a company's operations are usually not restricted to any single country (or region). Moreover, now that accounting standards have made firm-level data on business activity across different geographies widely available, a natural question is whether such data can be used to obtain more meaningful geographic exposure reporting of equity portfolios. Previous research on use of geographic segmentation data has primarily focused on improving forecasts of a company's earnings (see e.g. Roberts (1989), Balakrishnan et al. (1990) and Ahadiat (1993)). In this paper we analyse the usefulness of a company's reported geographic segmentation data (total sales disaggregated into sales from different geographies) in performance reporting and performance attribution. First, we analyse the application of geographic segmentation data in reporting the geographic exposure (proportion of sales coming from different geographies) of equity portfolios. We report geographic exposure of five developed market indices (S&P 500, STOXX Europe 600, FTSE Developed Asia Pacific, FTSE 100 and STOXX Europe 50) to four regions (Africa & Middle East, Americas, Asia & Pacific and Europe) and to emerging and developed markets.

1 - Source: http://unstats. un.org/unsd/methods/m49/ m49regin.htm

Second, we analyse the application of geographic segmentation data in

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An EDHEC-Risk Institute Publication