QS Investors Diversification Based Investing Whitepaper - FTSE

1 | Rationale and philosophy
DBI is based on three key beliefs:
1. Geography and industry are the primary drivers of global
equity risk
2. Market sentiment generates momentum effects in
capitalization-weighted indices, which leads to
concentration risk that builds and collapses
3. A diversified portfolio helps to avoid concentration risk
and reduces downside market participation
The rationale for the first two beliefs is given below. The third
is explained in section three, “Performance analysis”.
Figure 1: The importance of Country, Currency and Industry exposures
Explanatory Power of Gem Factors
Rolling 12-month average
100%
80%
60%
40%
20%
0%
Jan-1995
Jan-1996
FTSE DBI Page 4
Jan-1997
Jan-1998
Jan-1999
Jan-2000
Jan-2001
Belief 1 | Geography and industry drive global equity
risk and return
Geography (where a company is located or country and
currency) and Industry (what company a business is in) have
explained more than 90% of the factor risk in global equity
markets over the last 15 years. Other factors such as size,
value/growth, volatility and momentum, have explained less
than 10%. To illustrate this, Figure 1 shows the explanatory
power of BARRA’s Global Equity Market factors highlighting
that over a rolling 12-month basis that the Country, Currency
and Industry factors drive over 90% of the factor risk.
This is why DBI’s investment process focuses on geography
and industry as the key building blocks.
Jan-2002
Jan-2003
Jan-2004
Jan-2005
Jan-2006
Jan-2007
Jan-2008
Jan-2009
Source: BARRA, QS Investors analysis
Risk Indices
Industries
Currencies
Countries