Selecting Investment Analytic Framework for Both Top Down and Bottom Up Investors: Using Global Equity As the Example

Abstract

In establishing the foundation for their investment process, investors typically set up the investment framework first by dividing their investment universes into different buckets along the combinations of multiple sensible dimensions such as geography and industry. As the framework is applied to the entire investment process including alpha generation, portfolio construction, and risk management, it is fundamentally important for investment outcomes. Contrary to the current ad hoc approaches, I propose a methodology guided by economic intuitions to select the optimal framework among the feasible ones using global equities as the example. I find that the region sector framework is generally the optimal one among the possible combinations of the geography and industry dimensions for both developed and emerging markets. These results are important to both stock selection and asset allocation investing and to the academic research that often uses the country framework. The methodology can be easily adapted to other investment universes beyond global equities.

Keywords: JEL Classification Code: C10, C21, C22, C12, C50, C51, F21, F30, F65, G10, G11, G12, G14, G15, G23 global equities, investment framework, geographic, region, country, sector, industry, portfolio construction, alpha generation, risk management, stock selection, asset allocation, comovement, diversification benefits

JEL Classification: C10, C21, C22, C12, C50, C51, F21, F30, F65, G10, G11, G12, G14, G15, G23