Where Should Active Asian Equity Strategies Focus: Stock Selection or Asset Allocation

Abstract

The majority of active Asian equity strategies claim to derive their value addition by focussing their skill on security selection. We investigate if empirically this is the most appropriate area for an active Asian manager to focus on, in comparison to focussing on asset allocation as the mainstay of the investment process. Unlike US and European equity markets, Asia has two dimensions of allocation (both country and sector) and shallower liquidity for stocks. After accounting for differences in the opportunity set in terms of breadth and asset dispersion, we find that if a manager’s skill in asset allocation and stock selection were the same, then two-thirds of the portfolio’s return would come from asset allocation. This is in sharp contrast to a US equity portfolio, where this would be only 18%. In Asia, a manager's skill in security selection, would need to be almost double that in asset allocation for the return contribution from security selection to be equal or more than that from asset allocation. We therefore believe that for Asian equity portfolios, a much greater emphasis is required on the allocation process; a facet which seems to have been missed by asset managers thus far.