What is Country Picking?
Country Picking is a crucial asset allocation decision. There are several types of country, depending on the risk and return characteristics of a portfolio:
- Developed markets: the most industrialized economies with well-established economic systems.
- Emerging markets: Experiencing rapid industrialization and high rates of economic growth.
- Frontier Markets: "The next wave" of investment destinations, often riskier but offering superior return potential.
Asset classes within the same country show high correlation due to underlying fundamentals such as interest rates, credit, currency, and equity risk.
A good way of doing country picking is through ETFs. Indeed, investing directly in the debt or equities of individual companies is often more expensive than a country- or economy-specific index product, such as a country ETF. Country ETFs offer a high correlation with individual assets and lower transaction costs, making them attractive to investors.
Anomalies and Country Selection Strategies
Several studies have highlighted country selection strategies for international investors. These strategies are often parallels of effects and anomalies previously discovered in equities.
For example:
- Faber (2012) observed that countries with low CAPE ratios outperform those with high ratios.
- Balvers and Wu (2006) and Bhojraj and Swaminathan (2006) found evidence of momentum and reversal effects between countries.
- Gwilym, Clare, Seaton and Thomas have shown that momentum also works at the international level.
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Country risk
Before investing abroad, it is essential to assess the risk associated with a specific country. Country risk refers to the economic, political and commercial risks unique to a given country that could lead to unexpected investment losses.
Types of country risk
- Economic risk: Refers to a country's ability to repay its debts.
- Political risk: Refers to political decisions that could lead to unexpected losses for investors.
- Sovereign risk: Risk that the central bank will change its foreign exchange regulations, reducing or canceling the value of its foreign exchange contracts.
Country Risk Measurement
Rating agencies such as Moody's, S&P, and Fitch provide sovereign credit ratings to assess a country's ability to repay its debt. In addition, tools such as Euromoney's Country Risk Survey and the Economist Intelligence Unit's Country Risk Service Report offer in-depth country risk analyses.
Country Picking and Algo Trading
In the context of algo trading, country-level anomalies can be exploited to generate untapped alpha returns. With the right algorithmic tools, it is possible to capitalize on these anomalies and optimize country-picking strategies.
Although the number of anomalies discovered at country level is steadily increasing, it is still modest compared to the many anomalies identified at stock level. This makes country-picking investing a promising source of alpha that remains largely underexploited.
Conclusion
Country Picking is an essential strategy in the world of quantitative trading. With in-depth analysis and the use of algo trading, investors can successfully navigate the complexities of international markets, maximizing returns while minimizing risk.
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