CACEIS and EDHEC-Risk Institute have proposed an alternative approach to assessing the risks and performance of a portfolio, based on the actual geographic exposure of stocks.
In a new publication titled Accounting for Geographic Exposure in Performance and Risk Reporting for Equity Portfolios, the institute stated that analysis of portfolios should be based on ‘real’ economic activity and not only on the place of listing or nationality assigned in market indices.
The study found that in many cases, a stock’s official nationality will no match its actual geographic and economic exposure with regards to the company’s distribution of sales.
It therefore questioned the practice of classifying stocks in this way, as within the context of a global marketplace, a company’s operations are generally not restricted to a single country.
According to the study, in the majority of developed market indices the percentage of company sales generated outside of the official region of the index is significant, and has been on the increase for a number of years. For example, for the STOXX Europe 600, the index is predominantly non-European, and this change in exposure is likely to influence variations in the index performance.
There should be a clear distinction between those stocks that are actually exposed to the nationality of their index and those that are not, in order to compare performances, the study said.
It concluded that the current assessment methods of geographic exposures and diversification of portfolios present an incorrect overview, as it only takes in to account the place of listing, incorporation or nationality of an index.
As a result of the study, EDHEC-Risk Institute and CACEIS will encourage investors to take account of the real geographic risks of portfolios when making strategic or tactical decisions, helping asset managers to avoid compromising their allocation policy through poor geographic evaluation.
This study used geographic segmentation sales data, as introduced by the new international accounting rules for reporting activities of listed companies, within the context of geographic equity risk exposure assessment.
The research was conducted by EDHEC-Risk Institute with support from CACEIS, as part of the institute’s research on ‘new frontiers’ in risk and performance reporting.
