Region, sector and style selection in global equity markets

Abstract

This paper determines and decomposes the importance of region, industry sector, size and value–growth allocation policies within global equity portfolios and focuses on the interaction between these four equity allocation decisions. It also attempts to explain return variability over time and among stocks. The research results imply that equity allocations can be considered independently of each other; however, redundancy effects can be substantial. The authors find significant differences in the economic relevance of each of the allocation themes. In the time-series dimension (or in the long term), industry sector effects are more than twice as important as region effects and about six times more important than size and value effects. In the cross-sectional dimension (or in the short term), the differences between effects of equity allocation are smaller but still substantial. For both dimensions, industry sector effects are becoming more important. The explanatory power of allocation decisions within equity portfolios has implications for the structure of equity research as well as portfolio construction. This study reveals how to allocate research and risk budgets among the basic approaches to equity investment.