Sector, Style, Country Allocations All Have a Major Impact on Returns

By Matthew Hougan

The truth is that sectors, style and country allocations all have a major impact on returns.

The best study I could find on this is a bit old, but it's a good one: The October 2001 study "Country, Sector or Style," by Foort Hamelink, Hélène Harasty and Pierre Hillion, published by the International Center for Financial Management and Engineering.

You can download it here.

The paper aims to isolate the impact of sector, style and country allocations on a portfolio, something that is not easy to do. Does Switzerland perform a certain way because it's Switzerland, or because it has a high weighting of Financial stocks?

I won't go into the details, but the conclusion of the paper is that sectors are a primary determinant of returns, but not the determinant: size/style and country factors are important as well. The paper shows that the importance of sector factors is increasing, even as the importance of country weights is decreasing. That doesn't surprise me.

Turning back to our reader's specific question, one thing that surprised me was his focus on a U.S. allocation. Sectors strike me as one of the places where a truly global allocation makes sense. Do you really own the "Technology sector" if you don't own international giants like Samsung? Is the "Energy sector" complete without companies like BP (BP), Total (TOT) and others?

One last thought: I think the big reason that size/style remains the dominant form of asset allocation is because of the persistence of the small/value effect. The long-term data supporting the idea that small/value stocks deliver higher long-term returns is fairly convincing ... convincing enough that I believe even a dyed-in-the-wool indexer like Jim Wiandt has a small/value tilt in his portfolio. Isn't that right, Jim?