A year ago, Seeking Alpha published a piece of mine entitled "
Calculating Country Risk Observed By Betas
Since equity markets tend to go up and down in a synchronous
fashion with the world markets, owning a country risk itself means
owning a piece of the general "market risk". The article intended
to unearth systematic risks that an investor undertook merely by
the action of going long a certain country via an ETF or any such
The article talked about methodology related to capital asset
pricing model and displayed betas of various investable countries
with respect to a chosen world index, with an eye toward
distinguishing those that exposed investors to more risk and those
that exposed them to less risk.
A short review of capital asset pricing model is in order here.
Very briefly put, the model displays a security's return as a
function of the general market return. This relationship is
manifested by the security market line, which relates expected
returns to their non-diversifiable risks, in other words, their
A beta greater than one signifies high systematic risk, whereas
a beta less than one signifies low systematic risk.
Regressions were run for each country index return (dependent
variable) against the world index (independent variable), and slope
coefficients were found to be the countries' respective betas.
After ranking the results of countries according to betas
manifested during two-year and ten-year periods, the article made
the following conclusion, word for word:
An inference of this study (or so I reckon) is that if all
else is equal, it is more advisable to invest in nations with
higher than average growth potential that also show a low degree
of risk with respect to the world markets. The diversification
effects are also valuable. Of course, all else is never equal and
such quantitative studies should always be complemented by
fundamental analysis as well as due diligence.
For ease of reference, I'm including those countries that
returned a beta lower than one, or the market itself, directly from
the article published a year ago:
Country Betas : Two-Year Returns(as of December 2,
Correlation w/ Global Portfolio
Global St Deviation
An interesting result I had also mentioned in the article was
that the bottom of the list (i.e., countries exhibiting less
"systematic" risk) included those with higher than average growth
potential with respect to the rest of the world.
I must add that among the BRIC countries, only India made it
into this list. China barely missed the list with a somewhat low
beta. On the other hand, both Brazil and Russia missed this list
with a wide margin because they consistently keep showing betas
greater than one.
As an investor, if I were looking for "high-growth potential"
countries in this list, I would directly exclude any nation I find
that happens to be in the European region, perhaps with the
exception of those that are classified as Eastern or Emerging
Europe. No such luck here, so Greece, Portugal, and Switzerland
would be eliminated right off the bat from MY list of "high-growth
potential" countries. Japanese market clearly shows low systematic
risk, but it is just not feasible to expect aggressive growth from
Japan like China or India.
When Japan is thrown off this list, the investor is faced with
mostly emerging Asia exposure (South Korea, India, Singapore,
Indonesia, Hong Kong, Thailand, New Zealand, Philippines, Taiwan)
as well as some Middle Eastern and North African market exposure
(Israel, Egypt, Morocco), and finally Chile from South America.
The other caveat of this exercise is that it "suggests" buying
in baskets without paying any specific attention to any of the
countries mentioned in the list. It does not offer any due
diligence on the specific firms that may dominate these markets nor
does it provide fundamental analysis on the macro environments
governing any of these countries. Yet this is precisely what such
ranking methodologies and quantitatively oriented studies generally
offer, so the reader will have to go along with me here.
Jensen's Alpha is the intercept term remaining after a
regression is run, where the dependent variable is the country
return and the independent variable is the index that the country
return is compared against (i.e., world market return).
Calculations are performed on daily data in this exercise. Strict
calculations require subtracting the daily risk-free rate from both
the dependent and the independent variables before performing
In finance, Jensen's Alpha signifies whether the security (or
the country) has outperformed or underperformed the market (or the
world) index after accounting for the security's (or country's)
systematic risk, i.e., the beta.
However, while an in-sample alpha gives a good idea on how a
security or country has performed after getting rid of its beta
effect, it is an ex-post measure, meaning that it does not tell the
practitioner about how the specific security or country is going to
perform in the future with respect to its level of systematic risk.
So while alphas of each country regressions were informative, I did
not see the point of publishing the results because I was not
interested in the over or underperformance of countries up until
that time. I was specifically after trying to capture future alphas
while forming a basket of countries that manifested the least
amount of systematic risk.
Also, I ran the regressions without subtracting the risk-free
rates from independent and dependent variables, which has been done
in practice before. However, this action will affect the intercept
term, which will make the computed alphas less reliable.
Standard & Poors Index Services has continued maintaining
and publishing daily trading data for most of the countries that I
had calculated betas for a year ago. The world performance since
the time I wrote this piece has in general been stunning, so this
specific buy-and-hold study has definitely had considerable luck in
terms of timing.
Country Returnsfrom December 2, 2008 to December 2,
Returns have indeed been quite spectacular for the buy-and-hold
folks out there. It was definitely the right time to be optimistic,
specifically with regard to emerging market investing. What is more
surprising is that certain emerging nations that now occupy the top
of the list have been shown to display a consistently lower beta in
my earlier calculations that were published in the article.
In short, the performance of low-beta countries such as
Indonesia and India is even more spectacular than the performance
of countries like Brazil and Turkey, two countries that have been
known to display higher than average betas.
One of the great things about such "basket" portfolios is the
relative ease with which one is able to hold some "losers" among
the "winners" without knowing (or caring) a lot about why these
investments are losing money. Although there are no "losers" here
in absolute terms, Morocco, which was one of the countries within
the initial basket of 13, has been the worst "absolute" performer
among all the countries for which I could find continuous trading
Of course, the investor should not complain much given the fact
that Indonesia, India, South Korea, Singapore, Thailand, and many
other successful performers were also in the same basket.
For disclosure and clarification purposes, I did not personally
execute this strategy nor do I hold any of the ETFs associated with
the countries mentioned above. However, when I do buy stocks, I
tend to buy ten or twenty of them at the same time precisely
because I know that I cannot have a good grasp on everything that
has to do with one particular stock.
: Dude, why would I bother trying to have such a buy-and-hold
strategy published with an unalterable time stamp if I felt like it
was the wrong time to go public with it?
As much as I hate to admit it, the answer to this question is
certainly "yes". Even though my timing to write about such a
strategy had to do with self-selection, the article "recommends" a
very specific strategy. And this strategy has benefited
tremendously from the fact that world markets have registered a
return of 47 percent according to global index data provided by
Standard & Poors Index Services.
Such a strategy would face its true test if undertaken during a
period of falling global markets.
However, to shed some further light on the topic, I tried to
look at these returns after stripping away the general "market"
effect. I did that via subtracting the world index return
multiplied by the country's beta from the specific return of the
country. The excess return stripped from the general market
influences could give me more information on a specific country's
To clarify the point above, let's look at China's return:
Country Returnsfrom December 2, 2008 to December 2,
World Index Return )
Standard & Poors Index Services measures China return as
92.19%, some of which is attributable to the world index.
Multiplying China's registered beta with the world index return
gives 47.79%, and subtracting this number from the "raw return"
leaves us with an "excess" return of 44.39%.
This method looks like another round-about way to come up with
Jensen's alpha, but mathematically it's not equivalent because I'm
multiplying a yearly return number with a daily beta. Also the
world risk-free rate needs to be subtracted from both the country
and the world index return in order to comply with the theory,
which is not done here.
I know the methodology would face due academic criticism, but
I'll have to counter that via saying that the yearly "excess
returns" for all the countries are more or less in line with the
daily alphas that came out of the regressions I performed for the
past year's data.
The reason I decided to provide the yearly "beta-adjusted"
excess return estimate instead of the daily alpha is because it
looks more intuitive and tells more. Also, this metric falls when
you increase the country beta (undesirable) and rises when you
decrease the country beta (desirable).
For instance, if the Chinese market were more "risky", then the
beta-adjusted "excess" return would be less. If the Chinese beta
were 1.97 or above, this metric would turn negative. That would
mean that all of Chinese market's positive returns could be
attributable to the fact that the world markets had a successful
Which is precisely why investors should care about betas, or the
non-diversifiable risks that they are holding.
Let's look at the same list of returns after adjusting for each
country's respective beta:
Country Returnsfrom December 2, 2008 to December 2,
World Index Return )
The list changes somewhat, but Indonesia still manages to occupy
the first place. Brazil drops from second to fourth place due to
the high beta associated with the country, which is still
indicative of a stellar performance and high alpha. High beta
countries can register positive alphas, but it should be worth
mentioning that both Turkey and Russia drop in rank after taking
their higher than average respective betas into performance
The updated list of "excess returns" is even more biased towards
Eastern and Emerging Asia countries. We see an improvement in their
standing according to this metric because of their low betas
combined with high absolute returns.
On the other hand, the performance of G-10 countries, perhaps
with the exception of Belgium, Sweden, and Canada, has been
Indeed, most of the so-called "developed" world has suffered
from disappointing performance, with Australia clearly bucking the
trend. It is unfortunate that Japan does not benefit in the same
fashion from the dynamism of Eastern and Emerging Asia as much as
Yet the performance of the United States as the fourth worst
absolute performer and the second worst "relative" performer is
also worth mentioning.
These performance metrics are telling a story that is quite
discomforting for the U.S. equities. While dollar depreciation
during the measurement period may provide for an explanation, the
mathematical magnitude of the depreciation does not account for the
relative underperformance of U.S. equities. I am not even going to
go into a discussion about how currency depreciation could work in
favor of the equities of the country whose currency depreciates in
the long run.
The second part will try to look deeper into the currency
movements of most of these markets and mention some notable trends.
I will also provide an updated list of countries this strategy
"suggests" with a calculation of their last year's betas.
This portfolio basket strategy is not a recommendation to buy
specific stocks or ETFs. This is not a beta-neutral or portable
alpha strategy and does not provide for downside protection for
general market risk.
Disclosure: No positions
Is Indonesia Still an Attractive Play After a Major