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Industry
sector surpasses
country in global equity returns ...
ROTHSCHILD
REPORT NO.11
Is a country or an industry sector more important in determining global
and European share returns?
The
answer to this question has substantial consequences for the way global
portfolios should be managed.
Major US
fund manager Putnam Investments Inc. - which manages international
share funds on behalf of Rothschild clients - has carried out extensive
research into this question.
Putnam's
research indicates that sector has become more important than country
as an influence on returns over the past several years. Globalisation
of industries, such as energy, insurance, automobiles, and banking;
pan-European integration via the European Union; and the introduction
of the euro have been major drivers of this trend.
Data also
indicates that sources of return for global share portfolios rank
in the following order of importance: share specific, industry sector,
and country.
The research
suggests organising investments along industry sector lines while
paying close attention to country considerations.
In recent
years, there has been a worldwide narrowing of the gap between country
and industry sector effects on returns.
The response
of most European fund managers to this trend has been to rely on a
combination of factors - European economic integration and global
industry consolidation - to determine asset allocation. Major financial
institutions are increasingly organising along pan-European lines,
with some industries tracked as sectors and others researched along
country lines. However, the emergence of the internet and the rapid
growth and acquisition within corporate Europe have also undermined
traditional sector classification in many cases.
The result
has been a growing use of cross-sectoral analysis, particularly in
the technology/telecommunications/media area. These changes reflect
a widespread acknowledgment that the influence of nationality on European
shares has been waning since the mid 1990s and that industry sector
factors are increasing in relevance.
For its
research Putnam calculated the average correlations of companies within
a country and within a sector or industry group for the past seven
years versus the past three years. The results indicate that the co-movement
of company returns within countries is mostly decreasing, while correlations
within sector and industry groups are increasing. In fact, the utilities
sector was the only broad sector to show a decrease in correlation.
In Europe
and especially within the euro zone, industry sector has overtaken
country as an influence on equity returns. Basic structural shifts
in the European markets strongly suggest that industry sector influence
will have increasing relevance.
From a global
perspective, the industry sector effect is drawing even with that
of country. Tracking exposure along both industry sector and country
dimensions is, therefore, central to risk control. Whether changes
in the relative importance of factors affecting share prices are structural
or cyclical, global equity management will continue to involve a blend
of disciplined country, industry, and share-specific decisions into
the foreseeable future.
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