Country, Sector or Style: What Matters Most When Constructing Global Equity Portfolios? An Empirical Investigation from 1990-2001

Abstract

Equity returns are believed to be strongly influenced by country, sector and style effects. A key issue is to be able to disentangle those various effects from one another. In particular, differences between country returns may simply reflect differences in the sector composition of country markets, which makes it clearly difficult to disassociate both effects. Similarly, from 1999-2001 the relative performance of Growth versus Value might be solely due to the striking performance of the Technology and Telecommunication sectors. For global equity portfolio managers, it is crucial to identify which factors offer the highest diversification benefits and return potential. We apply a multifactor approach to estimate 'pure' country, sector and style factor returns. Using data going back to 1990, we identify the major changes that have occurred in developed markets until 2001. Our various indicators clearly point out the growing influence of sector factors. However, country effects remain important and there is no clear-cut evidence that sector factors dominate country factors. Style factors such as Growth, Value and Size also remain significant, even once sector and country effects are deduced. Finally, we show that momentum strategies based on sector returns offer substantial gains, while momentum strategies based on country returns do not. These findings suggest that, while diversification and return benefits from sector strategies have become substantial, managers should continue to monitor carefully country as well as style rewards and risks.