As global equity correlations among countries and regions have increased significantly over the past 20 years, lower correlated global sector indices can provide greater …..
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diversification benefits and potential return opportunities than traditional geographic strategies, according to a new report published by Standard & Poor’s, the world’s leading index provider.
As measured by correlations to the S&P Developed Broad Market Index (BMI), part of the S&P Global BMI, the average regional correlation of the S&P Developed BMI over the past 20 years is now 0.87, compared to just 0.80 for the average sector index. More recently, global regional correlations have increased to very high levels, with the average regional correlation rising to 0.95 over the past five years compared to 0.88 for the average sector correlation.
At a sector level, a number of sectors have shown unique patterns regardless of the countries in which they are domiciled, creating widely varying individual sector correlations to the S&P Developed BMI (Broad Market Index). Over the past 20 years, sectors such as Energy, Health Care and Utilities have correlations of just 0.67, 0.69 and 0.7 respectively, in comparison to Financials, which is highly correlated at 0.95.
The performance of sectors over the last 20 years has also varied widely, with the average percentage difference between the best and worst performing sectors at nearly 42%. In 1999, during the tech boom, this difference exceeded 111%, while 2009 was above-average at 56%. This divergence is also true on a risk-adjusted basis, which has shown sector returns over the past 20 years to be significantly more divergent when compared to the parent index.
Alka Banerjee, Vice President at S&P Indices, said: “In an environment marked by increasing global economic and financial market interdependence, global sector indices offer a unique source of portfolio diversification. Likewise, because of the highly divergent performance between sectors on both an absolute and risk-adjusted basis, global sector investing can provide opportunities for investors to potentially outperform broad global benchmarks in both up and down markets.”
The report also found that emerging markets, which are often seen as a reliable area for diversification, have shown an increase in correlation, with the five-year correlation of the S&P Emerging BMI to the S&P Developed BMI rising to 0.91 from a 15-year correlation of 0.82.
“It’s interesting to note that emerging markets are much less diversified than they were 15 years ago. The S&P Emerging BMI and Developed BMI are now highly correlated in comparison to the sector indices, providing further evidence of the benefits of implementing a sector investing strategy in order to maximise diversification,” said Banerjee.
The S&P Developed BMI and the S&P Emerging BMI together make up the S&P Global BMI (Broad Market Index), a comprehensive, rules-based index measuring global stock market performance. The index series has approximately 10,000 constituents.
Source: ETFWorld – Standard & Poor’s
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