Country Asset Allocation: Quantitative Country Selection Strategies in Global Factor Investing

270 Pages·2017·6.71 MB·English

by  Adam Zaremba

COUNTRY ASSET ALLOCATION
Quantitative Country Selection
Strategies in Global Factor Investing
ADAM ZAREMBA AND JACOB SHEMER
Country Asset Allocation
Adam   Zaremba • Jacob   Shemer
Country Asset
Allocation
Quantitative Country Selection Strategies in Global
Factor Investing
Adam   Zaremba Jacob   Shemer
Poznan University of Economics AlphaBeta, Tel Aviv, Israel
and Business
Poznan , Poland
ISBN 978-1-137-59190-6 ISBN 978-1-137-59191-3 (eBook)
DOI 10.1057/978-1-137-59191-3
Library of Congress Control Number: 2016956112
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F
OREWORD
Viewed from one angle, different country economies are nothing less than
aggregate investment entities of various fi rms and industries. As such,
investing across markets may simply be viewed as constructing a portfolio
of individual securities. In consequence, the investor should expect similar
return patterns surfacing both at the stock and the country level. Let’s
take the momentum effect. It implies that the best performing securities
will keep outperforming the past losers. If certain behavioral biases trigger
momentum among individual securities, this phenomenon can also arise
in country indices. Investors may as well chase, and overreact to, high
returns of the entire economies and underreact to other data. Perhaps,
analogous parallels could also be found among other cross-sectional pat-
terns setting value against growth or quality.
This book takes the new paradigm of factor investing—the innovative
practice of extracting abnormal returns and exploiting market anomalies—
and applies it to asset allocation at the global level. Contrary to the con-
ventional stock-level approach focusing on individual securities, the set
of investment strategies presented in this book captures entire economies
at the equity index level. The book details a range of strategies relying
on tactical asset allocation among different countries based on the latest
factors and anomalies discovered through empirical scientifi c research in
recent decades.
My personal career in the asset management industry throughout the
years has transitioned from traditional active management based upon
fundamental research to a complete quantitative approach. The reason for
this shift was very simple: if, to predict returns, one must confront both
v
vi FOREWORD
limited resources and his own limited attention span, employing quantita-
tive tools stemming from the science of asset pricing seems the best way of
overcoming these hurdles.
One striking fi nding from the science of asset pricing is both the range
and signifi cance of the information encapsulated in prices and returns,
which might be used to predict the stock price movement. In days gone
by, analysts strongly relied on the traditional fundamental analysis. The
dominant paradigm dictated that stock prices refl ected nearly all the infor-
mation available in the markets, and neither prices nor returns offered
any help in predicting future returns. As famously captured by the econo-
mist Paul Samuelson: “… there is no way of making an expected profi t
by extrapolating past changes in the futures price, by chart or any other
esoteric devices of magic or mathematics. The market quotation already
contains in itself all that can be known about the future and in that sense
has discounted future contingencies as much as is humanly possible”
(Samuelson 1965, p. 44).
As a result, fi nancial analysts were there to fi nd stocks with the intrinsic
value exceeding the market price in the hope to generate above-average
returns and any technical analysis was branded “voodoo economics”.
However, ever since Jegadeesh and Titman documented the momentum
anomaly in 1993, the studies of price-based patterns have proliferated. The
groundbreaking research by Jegadeesh and Titman (1993) has spurred
the discovery of many other anomalies in the cross-section returns based
solely on stock prices: low volatility, trend and time series momentum,
liquidity, skewness, and so forth. All these patterns enable us to extract
valuable information about future returns. Even if, to a large extent, these
anomalies result from various behavioral biases like herding or overre-
action, being aware of them can improve forecasting returns, which is
precisely the point of asset pricing and this book focusing on the country
factor investing. As many of these patterns emerge not only at the stock
level but also in the country prices space, they can be utilized for country
asset allocation.
Many anomalies identifi ed in the cross-section of stock returns converge
with the traditional way of thinking of the fundamental researcher, with
profi tability and accruals as fl agship examples. On the other hand, plenty
of the discovered anomalies go against the grain of standard intuitive
thinking, such as low volatility, asset growth, intermediate momentum,
and many more. No traditional investment manager ever imagined that
one could fi nd so much rich information in prices alone to help forecast
FOREWORD vii
relative returns across different security groups. This has been only pos-
sible thanks to the advancements in the science of asset pricing, which has
brought much welcome order to the asset management profession. In my
opinion, no investor will in future be able to ignore this scientifi c “new
deal”, especially given the limited attention span in the fast spinning world
of big data.
The main contribution of this book is to introduce academically proven
quantitative tools to the major sphere of global investing: country asset
allocation. By applying quantitative country selection strategies investors
will no longer need to rely solely on the analysis of the fundamental macro
conditions of the particular economy to select the right countries for their
portfolios.
Alpha Beta,
Tel Aviv, Israel J acob (Koby) Shemer
REFERENCES
Samuelson, P. A. (1965). Proof that properly anticipated prices fl uctuate randomly.
Industrial Management Review, 6 (2), 41–49.
Jegadeesh, N., & Titman, S. (1993). Returns to buying winners and selling losers:
Implications for stock market effi ciency. J ournal of Finance, 48 , 65–91.
P
REFACE
PRAISE FOR COUNTRY ASSET ALLOCATION: QUANTITATIVE
COUNTRY SELECTION STRATEGIES IN GLOBAL FACTOR
INVESTING
“Zaremba and Shemer provide a nice perspective on the important topic
of how to allocate investment portfolios across country markets. Their
book offers a non-technical discussion that nicely summarizes the exist-
ing academic literature on international portfolio choice with an eye on
the practical investment implications. I highly recommend the book to
practitioners, as well as academics who want to stay informed of the latest
developments in international portfolio choice.”
—Ronald Balvers, Professor, McMaster University, Canada
“Zaremba and Shemer provide a clear and accessible discussion of country
allocation strategies. They review how recent research has extended the
fi rm-level evidence on equity factor premia to the country level. Their
book is timely because investment managers now have access to a wide
range of low-cost and liquid products replicating country indices, so that
practitioners can implement country allocation strategies with ease.”
—Felix Goltz, Head of Applied Research, EDHEC-Risk Institute,
France
“The authors review the quantitative signals that forecast relative stock
returns within a country, and investigate whether the same signals work
in forecasting stock returns across country indices. Zaremba and Shemer
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x PREFACE
succeed on both fronts. The review is informed and succinct, and the
empirical investigation is thorough and impartial. Anyone interested in
global asset allocation should read this book.”
—Sandro C.  Andrade, Associate Professor of Finance, School of
Business Administration, University of Miami, USA
“This is a terrifi c book about country asset allocation. If you want to
improve your chances of investing well in the stock market, you must
read this book. The summary of empirical content is excellent. I highly
recommend this book for individual investors, portfolio managers, and
fund pickers.”
—Joseph D. Vu, Associate Professor, DePaul University, USA
“This book blends the best and latest research across a wide spectrum
of asset classes and investment strategies. Zaremba and Shemer indeed
provide a modern and insightful introduction to how global investment
practice could be improved in the twenty-fi rst century.”
—George Wang, Assistant Professor of Finance, Division of Accounting
and Finance, Manchester Business School, The University of Manchester, UK
“This book gives the reader a good introduction into the growing body of
literature on factor investing. It also gives empirical evidence by translating
these academic insights into a country selection strategy.”
—Pim van Vliet, Portfolio Manager, Conservative Equities at Robeco
“This book offers readers an accessible, well-cited, and appropriately criti-
cal review of popular equity return factors, a praiseworthy task given the
quantitative subject matter. More importantly, Zaremba and Shemer apply
these factors to the most important determinant of excess returns in inter-
national equity portfolios: country allocation. The results are informative,
illuminating the non-stationarity of factors, and are not to be overlooked
by anyone responsible for investing international assets.”
—Marshall L. Stocker, Global Macro Equity Strategist and Portfolio
Manager, Eaton Vance Management
A
CKNOWLEDGMENTS
We thank Professor Waldemar Frac̨kowiak from the Poznan University
of Economics who provided inspiration, insight and comments that
greatly assisted this research. Special thanks to Bartłomiej Dziec̨ iołowski,
Przemysław Konieczka, and Andrzej Nowak, who also contributed to
the development of this book. The research presented in this book was
a part of project no. 2014/15/D/HS4/01235 fi nanced by the National
Science Centre of Poland. The views expressed in this book are those of
the authors and not necessarily those of any affi liated institution.
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