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The Journal of Index Investing

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Country and Sector Bets: Should They Be Neutralized in Global Factor Portfolios?

Jennifer Bender, Rehan Mohamed and Xiaole Sun
The Journal of Beta Investment Strategies Summer 2019, 10 (1) 60-74; DOI: https://doi.org/10.3905/jii.2019.1.069
Jennifer Bender
is a senior managing director for Global Equity Beta Solutions at State Street Global Advisors in Boston, MA
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Rehan Mohamed
is a quantitative research analyst for Global Equity Beta Solutions at State Street Global Advisors in Bengaluru, India
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Xiaole Sun
is a vice president for Global Equity Beta Solutions at State Street Global Advisors in Boston, MA
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Abstract

A perennial question that comes up in the construction of factor portfolios is whether country and sector biases (in the form of active weights) should be neutralized. In this article, we review the assumptions that drive this decision, highlighting that both the portfolio construction framework and the desired portfolio criteria are critical to answering this question. We focus on two empirical examples—a rules-based approach to constructing the portfolio that is reflective of many current indexes in the marketplace and an optimization-based approach that is becoming an increasingly popular path. We corroborate past findings that indicated the answer depends on the portfolio construction framework. Moreover, it depends on the factor in question as well as the criteria—for example, returns, risk, information ratio, and turnover. If the returns and the information ratio are the focus, empirical evidence suggests some form of neutralization across both types of portfolio construction, particularly for value and size. When minimizing risk, maximizing the exposure per unit of tracking error and minimizing the turnover are the primary objectives, so the argument for neutralization is less clear.

TOPICS: Portfolio construction, factor-based models, portfolio theory

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The Journal of Index Investing: 10 (1)
The Journal of Beta Investment Strategies
Vol. 10, Issue 1
Summer 2019
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Country and Sector Bets: Should They Be Neutralized in Global Factor Portfolios?
Jennifer Bender, Rehan Mohamed, Xiaole Sun
The Journal of Beta Investment Strategies May 2019, 10 (1) 60-74; DOI: 10.3905/jii.2019.1.069

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Country and Sector Bets: Should They Be Neutralized in Global Factor Portfolios?
Jennifer Bender, Rehan Mohamed, Xiaole Sun
The Journal of Beta Investment Strategies May 2019, 10 (1) 60-74; DOI: 10.3905/jii.2019.1.069
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  • Article
    • Abstract
    • ACADEMIC MODELS AND THE COUNTRY AND SECTOR EFFECTS
    • EMPIRICAL EVIDENCE FROM PREVIOUS RESEARCH
    • IS THERE A RETURN PREMIUM FROM THE FACTOR CHARACTERISTICS OF COUNTRIES AND SECTORS?
    • TO NEUTRALIZE OR NOT TO NEUTRALIZE: INSIGHTS FROM TWO EXAMPLES OF POPULAR PORTFOLIO CONSTRUCTION TECHNIQUES
    • ARE THERE OTHER REASONS TO NEUTRALIZE COUNTRY AND SECTOR EFFECTS?
    • CONCLUSION
    • ACKNOWLEDGMENTS
    • APPENDIX A
    • APPENDIX B
    • ENDNOTES
    • REFERENCES
  • Info & Metrics
  • PDF (Subscribers Only)
  • PDF (Subscribers Only)

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