Country Factors vs. Industry Factors Stellar Asset Management Austin Kairnes Emre Kati Jae Hyun “Jacky” Lee David Russ Marika Schwartzman

Increasing Country Correlation n Declining trade barriers –GATT/ WTO –Trading Blocks (NAFTA) –Falling transportation costs n Increasing Economic Coordination –EMU –IMF

Our Analysis n Compare Mean-Variance Efficient Frontiers for –Country Portfolio (G7) –Industry Portfolio –Country-Industry Portfolio 5 countries (US, UK, Germany, Japan, France) 6 industries (banking, beverage/tobacco, construction, electronics, health, merchandising) n Test Trading Strategies for –Country Portfolio –Industry Portfolio

The Efficient Frontiers

High Industry Correlations

Potential Explanation The US is heavily weighted in all industries increasing industry correlation.

Fixed Weight Strategy Industry Portfolio Country Portfolio

Dynamic Weight Strategy Country Portfolio Oil = mthly price diff GTS = global term struct LPB = local P/B ratio LTS = local term struct

Dynamic Weight Strategy Industry Portfolio USTBill = mthly change in 90 day GPB = P/B for MSCI

Final Results

Conclusions n Country effects are dominant but industry tilts can add value. n A portfolio diversified on both country and industry factors will outperform a one factor portfolio. n An active allocation strategy to take advantage of the diversification benefits will be the best.