Asia Pacific Market Report AP Equities in Correlated World June 2012

Asia Pacific Market Report Asia Pacific Equities in a Correlated World June 2012
Asia Pacific Market Report
Asia Pacific Equities in a Correlated World

Zhijian Lou, Neil Gilfedder and Zoltan Nagy
Zhijian.Lou@msci.com Neil.Gilfedder@msci.com Zoltan.Nagy@msci.com
June 2012
Introduction
The 2008 financial crisis put global markets into a volatile risk-on / risk-off swing, where investors have been driven by two opposing views of the future. When people worry about recession or deflation, their risk aversion goes up and they shift to low-risk assets, thus hurting risky assets like equities. In contrast, when people expect a recovery or inflation, their risk aversion goes down and they shift into high-risk assets. This binary attitude results in a high degree of synchronization among the movements of different markets, thus causing a high degree of correlation. High levels of correlation may point to a common source of risk across all markets. Under these conditions, the higher the market correlation, the higher the portfolio volatility. This risk-on / risk-off climate has been with us for five years and investors are looking for ways to handle the correlated swings in global markets. In this paper, we examine these high correlations and see if they affect the Asia Pacific markets (ex-Japan). Barra regional models are used to gauge correlations among Asia, the U.S. and Europe, focusing on how Asia Pacific equities may be contaminated by global risk-on / risk-off swings.
Rising Correlations
While the economies in Asia Pacific have kept growing, there has been slow growth in the U.S. and austerity in Europe. Given its growth status, can we expect the Asia Pacific market to be exempt from the risk-on / risk-off asset allocation?
MSCI Applied Research 2012 MSCI. All rights reserved. Please refer to the disclaimer at the end of this document
msci.com
1 of 14
In Figure 1 through Figure 3, correlations of market returns have been compared between the pre-crisis and post-crisis periods. The cross-market rolling correlation tracks the strength of the common price component.1 Notice that the cross-market rolling correlations were pushed high and have remained high since the 2008 financial crisis. The pre-crisis correlation between Asia and U.S. fluctuated around zero, while the post-crisis correlation leaped into positive territory and remained there. Similarly, the rolling correlation between U.S. and Europe has steadily risen and has almost doubled after the crisis. Today it is up to an all-time high of 86 percent. In contrast, the relationship between Asia Pacific and Europe resembled an expanding sine wave, suggesting more volatility in the correlation.
Figure 1: Correlations of Market Returns: Asia Pacific and the U.S., Pre-Crisis versus Post-Crisis.
100%
Asia Pacific market and U.S. market

90% 80% 70% 60%
Rolling Correlation
50% 40% 30% 20% 10% 0% -10% -20% 2003-01-02
2005-10-20
2008-08-07
2011-05-26
1 The region/country factors of three Barra equity models are used to calculate daily returns of three regional markets. Daily returns of Asia Pacific markets are estimated with the Barra Asia Pacific Equity Model ex Japan (ASE1SXJP) and MSCI All Country (AC) Asia Pacific ex Japan Index. Daily returns of the U.S. market are estimated with Barra U.S. Equity Model (USE4S) and the MSCI USA Index. Daily returns of Europe markets are estimated with the Barra Europe Equity Model (EUE3S) and the MSCI Europe Index. All the three regional returns are denominated in USD.
msci.com
2 of 14
Figure 2: Correlations of Market Returns: Asia Pacific and Europe, Pre-Crisis versus Post-Crisis.
100% 90% 80% 70% 60%
Asia Pacific market and Europe market
Rolling Correlation
50% 40% 30% 20% 10% 0% -10% -20% 2003-01-02
2005-10-20
2008-08-07
2011-05-26
Figure 3: Correlations of Market Returns: the U.S. and Europe, Pre-Crisis versus Post-Crisis.
100% 90% 80% 70% 60%
U.S. market and Europe market
Rolling Correlation
50% 40% 30% 20% 10% 0% -10% -20% 2003-01-02
2005-10-20
2008-08-07
2011-05-26
msci.com
3 of 14
These higher levels of the post-crisis correlation suggest that the returns from Asia Pacific markets have become increasingly similar with the U.S. and Europe. Relative to market returns, macro volatility appears to be a more significant driver of stock correlations. Figure 4 through Figure 7 compares the correlation of market volatilities between the pre-crisis and post-crisis periods.2
Figure 4: Correlations of Market Volatilities: Asia Pacific and the U.S., Pre-Crisis.
50%
Pre-crisis: Asia vs US (2003-2006)
40%
Asia Pacific
30%
Asia = 0.94*US - 0.01 R = 41%
20%
10% 10% 15% 20% 25%
U.S.
2 Daily volatilities of region/country factors are calculated across three regional markets. Daily volatilities of Asia Pacific market are estimated with Barra Asia Pacific Equity Model ex Japan (ASE1SXJP) and MSCI AC Asia Pacific ex Japan Index. Daily volatilities of U.S. market are estimated with Barra U.S. Equity Model (USE4S) and MSCI USA Index. Daily volatilities of Europe market are estimated with Barra Europe Equity Model (EUE3S) and MSCI Europe Index. All the three regional volatilities are denominated in USD.
msci.com
4 of 14
Figure 5: Correlations of Market Volatilities: Asia Pacific and the U.S., Post-Crisis.
50%
Post-crisis: Asia vs US (2007-2012)

40%
Asia Pacific
30%
20%
Asia = 1.27*US - 0.08 R = 82%

10% 10% 20% 30% 40% 50% 60%
U.S.
In the volatility landscape, the Asia Pacific market has become far more correlated with the U.S. and Europe after the financial crisis. Correlations before the crisis were not impressive, with R-squares at 40 percent. After the crisis, however, the correlations increased, with R-squares rising to 80 percent. The results suggest that disparate equity markets have a much greater tendency to move together than before, and individual stocks are increasingly dominated by a common price component.
Figure 6: Correlations of Market Volatilities: Asia Pacific and Europe, Pre-Crisis.

50%
Pre-crisis: Asia vs Europe (2003-2006)

40%
Asia Pacific
Asia = 1.71*EU - 0.10 R = 48%

30%
20%
10% 10% 15% 20% 25%
Europe
msci.com
5 of 14
Figure 7: Correlations of Market Volatilities: Asia Pacific and Europe, Post-Crisis.

50%
Post-crisis: Asia vs Europe (2007-2012)
40%
Asia Pacific
30%
20%
Asia = 0.88*EU + 0.01 R = 81%

10% 10% 20% 30% 40% 50%
Europe
As shown in Figure 5, the U.S. market volatilities are not only mirrored in the Asia Pacific region, but even amplified by a factor of 1.27 in the post-crisis period. Similar to a high-beta stock, a more volatile market is likely to underperform in a down-market. In fact, the MSCI Asia Index did underperform the MSCI USA Index during the last five years. As the one growing economy in the world, the Asia Pacific region ends up much choppier than other regions trapped in recession. Why? Asia has long been a fast-growing territory; paradoxically, that happens to be the source of its weakness, since the flip side of Asias strength is its dependency on the demand of other markets. A severe balance-sheet recession dries up global demand, which exposes Asias weakness. That explains how Asia Pacific exposures might become another risk-on manifestation despite its growth status.
Country Diversification in Asia

Any stock has an exposure to macro risk and some stock specific alpha. An increase of cross-market correlation could deplete Asia-specific sources of returns. With all the markets behaving a similar way, many wonder: is there any Asia-specific return remaining? In fact, these returns are still available, and we can trace them through two distinct channels. First, to what extent is Asia dominated by the global common price component? Asias return correlation with other regions remains weak in comparison to other markets; the recent April 2012 figure highlights the point. As shown in Figure 1, Asia has a weak, albeit positive, relationship to the U.S. with a correlation in the low teens. By contrast, the correlation between the U.S. and Europe remains at an all time high of 85-86 percent.
msci.com
6 of 14
Second, to what extent is Asia internally correlated? By comparing the country effect between Asia versus Europe markets,3 we found that the benefit of country diversification is rich in Asia, but negligible in Europe. Figures 8 10 are illustrative.4
Figure 8: Country Risk: Asia Pacific and Europe.
5%
4%
3%
Country Risk
2%
Asia Pacific
1%
Europe
0% 2002
2004
2005
2006
2008
2009
2010
2012
The first chart (Figure 8) shows that the Asia Pacific region has had much higher volatility of country factors than its regional counterpart in Europe. Higher country risk tends to have a larger size of country factor returns, indicating that a proper country allocation in the Asia Pacific market could be a built-in mechanism of risk reduction and return enhancement.
3 4
The Barra Asia Pacific Equity Model ex Japan covers 14 countries (ASE1xJP) and the Barra Europe Equity Model include 29 countries (EUE3).
Asia Pacific country volatilities, country risk contributions and correlations are estimated with Barra Asia Pacific Equity Model ex Japan (ASE1SJP) and the MSCI AC Asia Pacific ex Japan Index. Europe country volatilities, country risk contributions and correlations are estimated with Barra Europe Equity Model (EUE3S) and the MSCI Europe Index.
msci.com
7 of 14
Figure 9: Risk Contribution of Country Factors, Asia Pacific versus Europe.
0.0%
-0.8%
Country Risk Countribution
-1.6%
-2.4%
Asia Pacific Europe

-3.2% 2002 2004 2005 2006 2008 2009 2010 2012
In the second chart (Figure 9), we see a negative risk contribution of country factors. The negative value of risk contribution confirms that diversification might benefit Asia Pacific investors through diverse country allocations. By contrast, such a diversification effect was negligible for Europe markets.
msci.com
8 of 14
Figure 10: Correlation of Country Factors to the Underlying Market, Asia Pacific versus Europe.
20%
0%
Correlation
-20%
-40%
-60%
Asia Pacific Europe

-80% 2002 2004 2005 2006 2008 2009 2010 2012
Lastly, the third chart (Figure 10) tracks the source of diversification. The country-factor returns have a strong and negative relationship with the underlying market. In the Asia Pacific, such a negative correlation has remained steady over time in a range of 40 to 60 percent with only a brief dip into the high teens during the 2005 credit stress and the 2003 deflation fear. Even in late 2008 and early 2009, hammered by extreme market moves, the negative correlations stayed as high as 60 percent and the diversification benefits reached an historical high. The negative correlation, however, collapsed to an all-time low of 10 percent since the second half of 2011, and so did diversification benefits. There could be two potential explanations. It could be a temporary dip, as it happened before, due to a massive repatriation of money back to Europe as a result of the eurozone banking crisis last year. It might also represent an early signal of major structural shift in the Asia Pacific region as the Chinese economy slows down.
msci.com
9 of 14
Conclusion
Asset management has become more challenging with disparate markets moving in lockstep and swinging between risk-on and risk-off phases. An elevated cross-market correlation has even spilled over into an unlikely place the Asia Pacific market. Through the lens of the Barra regional models, we see that the Asia Pacific market tends to follow, and even amplify, U.S. market volatilities. However, this correlation does not diminish the market identity of the Asia Pacific region. In our study, the Barra models helped to uncover diversification benefits embedded in the country factors. Our analysis suggested that searching for Asia Pacific alpha has become more urgent, and challenging, as macroeconomics movements matter more and more in this correlated world.
msci.com
10 of 14
Appendix: Monthly Asia Pacific Market Equity Watch

Market Environment
Figure 11: Performance and Risk Forecast, MSCI AC Asia Pacific ex Japan IMI, December 1994 April 2012.
250
35%
200
30%
150
25%
100
20%
50
15%
10%
All Country Asia ex Japan IMI Index
Asia ex Japan Regional Factor Risk (right axis)
Figure 12: Performance and Risk Forecast, MSCI AC Asia Pacific ex Japan IMI, October 31, 2011 30 April 30, 2012.
120 115 110 21.0% 105 100 95 90 18.5% 85 80 18.0% 17.5% 20.5% 20.0% 19.5% 19.0% 22.5% 22.0% 21.5%
All Country Asia ex Japan IMI Index
Asia ex Japan Regional Factor Risk (right axis)
msci.com
11 of 14
Figure 13: Risk Forecast for the Regional Factor, Asia Pacific ex Japan Model Long and Short Versions, December 1994 April 2012.
45% 40% 35% 30% 25% 20% 15% 10% 5%
Asia ex Japan Regional Factor Risk (right axis) long model Asia ex Japan Regional Factor Risk (right axis) short model
Figure 14: Risk Forecast for the Regional Factor, Asia Pacific ex Japan Model Long and Short Versions, 31 October 2011 30 April 2012.
25% 24% 23% 22% 21% 20% 19% 18% 17% 16% 15%
Asia ex Japan Regional Factor Risk (right axis) long model Asia ex Japan Regional Factor Risk (right axis) short model
msci.com
12 of 14
Figure 15: Risk Forecasts of the Five Most Risky Countries, ASE1XJP Model, December 1996 April 2012.
60% 50% 40% 30% 20% 10% 0%
China Domestic
Indonesia
India
Pakistan
Thailand
Figure 16: Risk Forecasts of the Five Most Risky Countries, ASE1XJP model, 31 October 2011 30 April 2012.
30%
25%
20%
15%
10%
China Domestic
Indonesia
India
Pakistan
Thailand
msci.com
13 of 14
Client Service Information is Available 24 Hours a Day

clientservice@msci.com
Americas
Americas Atlanta Boston Chicago Montreal Monterrey New York San Francisco Sao Paulo Stamford Toronto 1.888.588.4567 (toll free) + 1.404.551.3212 + 1.617.532.0920 + 1.312.675.0545 + 1.514.847.7506 + 52.81.1253.4020 + 1.212.804.3901 + 1.415.836.8800 + 55.11.3706.1360 +1.203.325.5630 + 1.416.628.1007
Europe, Middle East & Africa

Amsterdam Cape Town Frankfurt Geneva London Madrid Milan Paris Zurich + 31.20.462.1382 + 27.21.673.0100 + 49.69.133.859.00 + 41.22.817.9777+ 44.20.7618.2222 + 34.91.700.7275 + 39.02.5849.0415 0800.91.59.17 (toll free) + 41.44.220.9300
Asia Pacific
China North China South Hong Kong Seoul Singapore Sydney Tokyo 10800.852.1032 (toll free) 10800.152.1032 (toll free) + 852.2844.9333 +827.0768.88984 800.852.3749 (toll free) + 61.2.9033.9333 + 81.3.5226.8222
Notice and Disclaimer

This document and all of the information contained in it, including without limitation all text, data, graphs, charts (collectively, the Information) is the property of MSCl Inc., its subsidiaries (including without limitation Barra, Inc. and the RiskMetrics Group, Inc.) and/or their subsidiaries (including without limitation the FEA, ISS, and CFRA companies) (alone or with one or more of them, MSCI), or their direct or indirect suppliers or any third party involved in the making or compiling of the Information (collectively (including MSCI), the MSCI Parties or individually, an MSCI Party), as applicable, and is provided for informational purposes only. The Information may not be reproduced or redisseminated in whole or in part without prior written permission from the applicable MSCI Party. The Information may not be used to verify or correct other data, to create indices, risk models or analytics, or in connection with issuing, offering, sponsoring, managing or marketing any securities, portfolios, financial products or other investment vehicles based on, linked to, tracking or otherwise derived from any MSCI products or data. Historical data and analysis should not be taken as an indication or guarantee of any future performance, analysis, forecast or prediction. None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), or a promotion or recommendation of, any security, financial product or other investment vehicle or any trading strategy, and none of the MSCI Parties endorses, approves or otherwise expresses any opinion regarding any issuer, securities, financial products or instruments or trading strategies. None of the Information, MSCI indices, models or other products or services is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. The user of the Information assumes the entire risk of any use it may make or permit to be made of the Information. NONE OF THE MSCI PARTIES MAKES ANY EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION (OR THE RESULTS TO BE OBTAINED BY THE USE THEREOF), AND TO THE MAXIMUM EXTENT PERMITTED BY LAW, MSCI, ON ITS BEHALF AND ON THE BEHALF OF EACH MSCI PARTY, HEREBY EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING, WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NONINFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION. Without limiting any of the foregoing and to the maximum extent permitted by law, in no event shall any of the MSCI Parties have any liability regarding any of the Information for any direct, indirect, special, punitive, consequential (including lost profits) or any other damages even if notified of the possibility of such damages. The foregoing shall not exclude or limit any liability that may not by applicable law be excluded or limited, including without limitation (as applicable), any liability for death or personal injury to the extent that such injury results from the negligence or willful default of itself, its servants, agents or sub-contractors. Any use of or access to products, services or information of MSCI requires a license from MSCI. MSCI, Barra, RiskMetrics, ISS, CFRA, FEA, EAFE, Aegis, Cosmos, BarraOne, and all other MSCI product names are the trademarks, registered trademarks, or service marks of MSCI in the United States and other jurisdictions. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poors. Global Industry Classification Standard (GICS) is a service mark of MSCI and Standard & Poors.
About MSCI
MSCI Inc. is a leading provider of investment decision support tools to investors globally, including asset managers, banks, hedge funds and pension funds. MSCI products and services include indices, portfolio risk and performance analytics, and governance tools. The companys flagship product offerings are: the MSCI indices with approximately USD 7 trillion estimated to be benchmarked to them on a worldwide basis ; Barra multi-asset class factor models, portfolio risk and performance analytics; RiskMetrics multi-asset class market and credit risk analytics; MSCI ESG (environmental, social and governance) Research screening, analysis and ratings; ISS governance research and outsourced proxy voting and reporting services; FEA valuation models and risk management software for the energy and commodities markets; and CFRA forensic accounting risk research, legal/regulatory risk assessment, and due-diligence. MSCI is headquartered in New York, with research and commercial offices around the world.
1
As of June 30, 2011, based on eVestment, Lipper and Bloomberg data.
msci.com
14 of 14

Asia Pacific Market Report AP Equities in Correlated World June 2012

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Asia Pacific Market Report AP Equities in Correlated World June 2012

Uploaded by

Copyright:

Available Formats

Asia Pacific Market Report Asia Pacific Equities in a Correlated World June 2012

Asia Pacific Market Report

Asia Pacific Equities in a Correlated World

Asia Pacific market and U.S. market

50% 40% 30% 20% 10% 0% -10% -20% 2003-01-02

Asia Pacific market and Europe market

50% 40% 30% 20% 10% 0% -10% -20% 2003-01-02

U.S. market and Europe market

50% 40% 30% 20% 10% 0% -10% -20% 2003-01-02

Pre-crisis: Asia vs US (2003-2006)

Asia = 0.94*US - 0.01 R = 41%

10% 10% 15% 20% 25%

Post-crisis: Asia vs US (2007-2012)

Asia = 1.27*US - 0.08 R = 82%

Figure 6: Correlations of Market Volatilities: Asia Pacific and Europe, Pre-Crisis.

Pre-crisis: Asia vs Europe (2003-2006)

Asia = 1.71*EU - 0.10 R = 48%

10% 10% 15% 20% 25%

Figure 7: Correlations of Market Volatilities: Asia Pacific and Europe, Post-Crisis.

Post-crisis: Asia vs Europe (2007-2012)

Asia = 0.88*EU + 0.01 R = 81%

Country Diversification in Asia

Figure 9: Risk Contribution of Country Factors, Asia Pacific versus Europe.

Country Risk Countribution

Asia Pacific Europe

Asia Pacific Europe

Appendix: Monthly Asia Pacific Market Equity Watch

All Country Asia ex Japan IMI Index

Asia ex Japan Regional Factor Risk (right axis)

All Country Asia ex Japan IMI Index

Asia ex Japan Regional Factor Risk (right axis)

60% 50% 40% 30% 20% 10% 0%

Client Service Information is Available 24 Hours a Day

Europe, Middle East & Africa

Notice and Disclaimer

As of June 30, 2011, based on eVestment, Lipper and Bloomberg data.

You might also like