July-August 2015

EDHEC RESEARCH: Consumer risk

ConsumerDeveloped market companies have increasing exposure to non-domestic regions and to emerging markets – which has implications for reporting the geographic risk exposure of equity portfolios, says the Edhec-Risk Institute.

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.

In recent research (Accounting for Geographic Exposure in Performance and Risk Reporting for Equity Portfolios, Edhec-Risk Publication, March 2015) produced as part of the Caceis research chair at Edhec-Risk Institute, 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.

In what follows, we summarise some of the results of the application of segmentation data for reporting the geographic risk exposure and performance attribution of equity portfolios.

PERFORMANCE AND RISK REPORTING
First, we report the exposure of the developed market indices to four regions (Table 1) and to developed and emerging markets (Table 2). The exposure is reported for the beginning (FY-2003) and end (FY-2012) of our 10-year sample period.

In FY-2003, all the indices (including Stoxx Europe 600, FTSE Developed Asia-Pacific, and FTSE 100, which are not shown in the table) have significant exposure to non-domestic regions. For example, the exposure of the S&P 500 to regions other than Americas is 19%. The exposure of the Stoxx Europe 50 to non-domestic regions (regions other than Europe) is highest at 44%. 

Over a period of 10 years, the exposure of the five indices to non-domestic regions has further increased. For example, the exposure of the S&P 500 to regions other than the Americas has increased by 8% in a period of 10 years to 27% in FY-2013. 

To give another perspective on the importance of growing foreign market exposure of the developed market indices, we find that for indices such as the S&P 500 and Stoxx Europe 600, the sum of market capitalisation of the index constituents weighted by percentage of sales coming from foreign markets was $2,852 billion (or 29.96% in relative terms) and $2,469 billion (or 41.07%), respectively, in June 2004, which rose to $5,638 billion (38.75%) and $4,683 billion (53.28%), respectively, in June 2013. 

We thus see a clear trend for foreign geographic exposure to constitute an increasingly important part of popular regional indices, while the importance of companies with a clear focus on the official region of the index in terms of geographic exposure has decreased correspondingly.

In Table 2, we provide emerging and developed market exposure of selected developed market indices. All the developed market indices under study (including those not shown) had noticeable exposure to emerging markets in FY-2003, wherein the S&P 500 and Stoxx Europe 600 had the lowest (6.97%) and highest (10.67%) exposure respectively. Interestingly, the emerging market exposure of all the developed market indices has almost (or more than) doubled in the 10-year sample period.

Also, we find that for popular indices such as the S&P 500 and Stoxx Europe 50, the sum of market capitalisation of the index constituents weighted by percentage of sales coming from emerging markets increased between June 2004 and June 2013. 

The figures also highlight the rise in the emerging market exposure of developed market indices.

The figures reported in Tables 1 and 2 tell us that the developed market indices have significant and increasing exposure to non-domestic regions and to emerging markets, which underlines the need to report geographic risk exposure of equity portfolios in terms of geographic segmentation data and not just to rely on simplistic labelling of indices based on a stock’s place of listing or incorporation.

PERFORMANCE ATTRIBUTION
Here, we summarise the application of segment data in the performance attribution of equity portfolios. We analyse the contribution of stocks with varied emerging and local market exposure to the performance of developed market indices. We focus on performance attribution conditioned on two different market conditions: performance attribution depending on spread in return of emerging and developed market equity and performance attribution depending on spread in return of local and emerging market equity. To emphasise the core idea, we report performance attribution during a bull market, i.e. when the return on emerging market (or local market) equity is higher than the return on developed market (or foreign market) equity.

Table 3 reports return contributions to developed market indices of stocks with varying emerging market exposure in bull market conditions. We note that during bull markets (i.e, when the emerging market performed better than the developed market) the stocks with high exposure to the emerging market contributed more to the performance of the index compared to the contribution of stocks with low exposure to the emerging market. 

For example, during bull markets, the contribution of high emerging market exposure stocks to the performance of the Stoxx Europe 600 is 7.83% compared to the contribution of low emerging market exposure stocks (5.47%).

LOCAL VS FOREIGN
From looking at data for contributions to developed market indices of stocks with varying local (official regions) and foreign market exposure (table not shown), we note that during bull markets (i.e. when local markets performed better than foreign markets), the stocks with high exposure to local markets contributed more to the performance of the index compared to the contribution of stocks with low exposure to local markets. 

For example, during bull markets, the contribution of high local market exposure stocks to the performance of FTSE Developed Asia Pacific is 7.53% compared to the contribution of low local market exposure stocks (4.40%).

Overall, these figures suggest that when emerging markets fare better than developed market equity, the stocks with higher exposure to emerging markets contribute more to the performance of indices than stocks with lower exposure to emerging markets. Likewise, we find that when local markets fare better than foreign market equity, the stocks with higher exposure to local markets contribute more to the performance of indices than stocks with lower exposure to local markets. 

As we measure the exposure of stocks in terms of proportion of sales coming from emerging or local markets, it again underlines the usefulness of using geographic segmentation data in analysing the performance of equity portfolios.

In this paper, we analyse the usefulness of geographic segmentation data in reporting the geographic risk exposure and performance attribution of equity portfolios. We find that the indices that are labelled as representing developed market equity have significant and increasing exposure to emerging markets. More globally, we observe that the economic exposure measured by sales in the domestic region that corresponds to the official definition of the index’s universe has been tending to fall sharply compared to exposure to non-domestic regions. These economic exposures ultimately have an influence on variations in the performance of the index. As such, we find that the contribution to the performance of developed market indices of stocks with varied geographic exposure (either emerging market or local market exposure) differs noticeably. These findings highlight the usefulness of geographic segmentation data in risk reporting and performance attribution of equity portfolios.

This reporting will also allow investors to take account of the real geographic risks of their portfolios, whether involving the construction of a strategic or tactical allocation. It would be a shame if asset allocators compromised their asset allocation policy, which is often based on macro-economic scenarios that use regional dimensions, through poor evaluation of the geographic reality of their portfolio or benchmark.

Edhec tables

Authors: Noël Amenc, Kumar Gautam, Felix Goltz and Nicolas Gonzalez

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