Equity Market Segmentation in Risk-Based Portfolio Construction Techniques

Abstract

Risk-based portfolio construction models—i.e., strategic asset allocation approaches that do not make use of expected returns as inputs, such as optimal risk parity, most diversified portfolio, global minimum variance, and equal weighting—have reached a widespread use in the asset management industry. The aim of this research is to verify how these techniques reach different results depending on whether the global equity market is subdivided on the basis of a sector breakdown, carried out according to the industry sectors of each company, or in function of a geographical breakdown, carried out according to the listing market of each company. An empirical analysis, applied on a representative sample of global equity market indexes calculated by MSCI, is implemented by making use of the typical and most advanced statistical and financial evaluation measures. This comparative analysis reaches consistent results, showing a significant preference for the sector breakdown compared to the geographical one. In conclusion, this outcome can be ascribed to the segmentation of the equity market into sector indexes characterized by better external differentiation and stronger internal coherence. Moreover, sector indexes are characterized by a lower degree of concentration in comparison to the geographical ones.