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Practice paper

The relevance of the country and sector effect in global equity returns around COVID-19 and developed and emerging markets

Francis Boateng-Frimpong, Amel Bentata and Rémy Cottet
Journal of Risk Management in Financial Institutions, 17 (2), 213-230 (2024)
https://doi.org/10.69554/RRCR9566

Abstract

This study explores the historical and current explanatory power of country classification and Global Industry Classification Standard sector classification on global equity returns in the equally weighted MSCI All Country World Index. R2 is a crucial statistical tool for risk and portfolio management professionals because it serves as a measure of how much of a portfolio's movements can be explained by factors. Its significance lies in its ability to quantify how dependent a portfolio's risk is on those factors. The country classification's adjusted R2 is dominant in global equities, driven by its dominance within emerging markets (EM). Within developed markets (DM), the country effect's slight dominance over the sector effect has decreased over time — the two have become more balanced since 2015, with the sector effect having a slightly higher adjusted R2 value. There was a drop in the R2 for all classifications during the COVID-19 pandemic. This drop was most significant in the country classification, with a sharp decline to 8.3 per cent, well below its previous historical minimum of 12 per cent, before it rebounded to its historical range. This change drove further analysis into the country effect across EM and DM, where the large drop and rebound were primarily within EM. During this time, the sector effect dropped but remained within its historical range, implying a larger loss of diversification benefit in country effect than in sector effect. The impact of Chinese stocks on country effect within EM is also investigated. In 2018, there was a large influx of Chinese companies into the index, which caused a decline in country diversification and hence a reduction in explanatory power within EM. China's rapid and strict COVID-19 response, early tight monetary policy and regulatory crackdown have since caused it to become increasingly differentiated from the rest of EM, increasing country diversification within EM and causing the accentuated rebound in explanatory power of the country effect post-COVID-19. Risk managers can use these results to validate the use of sector and country classifications in portfolio construction.

Keywords: GICS classification effect; country effect; diversification; portfolio construction; regression; emerging markets; China

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Author's Biography

Francis Boateng-Frimpong was an investment analyst in the Fixed Income Strategy & Solutions team at Pictet Asset Management. After completing a 10-week internship in the Developed Equities team based in London, conducting research in the healthcare sector, he subsequently joined the graduate programme. His training included rotations across various investment teams including distressed/special situations, developed credit, emerging long/short fixed income and quantitative equities. He also co-founded the startup InvestBlack and acted as a mentor for various social enterprises aimed at broadening access to careers in the financial sector. Francis held a MEng degree in integrated mechanical and electrical engineering from the University of Bath.

Amel Bentata is a senior quantitative analyst. Prior to joining Pictet Asset Management SA in 2021, she spent six years at Bluecrest Capital Management in the systematic equities and rates team. Prior to that, she was a credit quantitative analyst at Société Générale. Amel holds a PhD in mathematics and a master's in mathematics from the University Paris 6, and a diploma in mathematics from the Ecole Normale Supérieure de Paris-Ulm.

Rémy Cottet joined Pictet in 2014. He is a senior quantitative analyst in the Investment Solutions team and held a similar position in the Quantitative Absolute Return team. Before joining Pictet, Rémy worked for Man AHL Investments for seven years as a senior quantitative analyst, before becoming Head of the Strategic Research team. He also held a lecturer position in economics and business statistics at the University of Sydney. Rémy holds a PhD in econometrics from the University of Sydney and a bachelor's degree in mathematics from the University of Geneva.

Citation

Boateng-Frimpong, Francis, Bentata, Amel and Cottet, Rémy (2024, March 1). The relevance of the country and sector effect in global equity returns around COVID-19 and developed and emerging markets. In the Journal of Risk Management in Financial Institutions, Volume 17, Issue 2. https://doi.org/10.69554/RRCR9566.

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cover image, Journal of Risk Management in Financial Institutions
Journal of Risk Management in Financial Institutions
Volume 17 / Issue 2
© Henry Stewart
Publications LLP

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