One could conclude that the international evidence in favor of these investment factors is poor.
Yet Table 2 suggests a different perspective: consistently high regional correlations indicate that these factors are unlikely the byproduct of chance.
The region-specific component reflects potentially uncompensated risk, which can be diversified away by simply investing across national markets.
In Table 3, we evaluate the performance of the global components of the market, value, size, momentum, investment, and profitability factors.
Our third insight is that factor strategies tend to exhibit higher correlations across regions during economic downturns.
As is the case within major asset classes, the benefits of diversification weaken when most needed.
Table 2 shows that the regions’ portfolios tend to be significantly correlated.
For instance, across the eight regions, the value portfolios display an average correlation of 41%, whereas the momentum portfolios’ average is 56%.
We also examine whether geographical diversification exhibits time-varying properties.Because of a strong correlation with the first principal component of each equity factor, we conclude that a simple average of the excess returns across the eight regions offers an accurate measure of a global factor.Except for size, the global factor portfolios are all statistically significant, and the t-statistics of the value, momentum, and profitability factors are above 3.The significance of these global equity factors raises at least two questions.First, can the global factors explain the average excess returns associated with the regional portfolios of Table 1?How should one interpret this international evidence?We argue that regional factor portfolios reflect both common variation, which we define as the global factor, and region-specific variation.The magnitude of these correlations is similar if computed between the excess returns of the US portfolios and the average excess returns of the remaining seven regions.In particular, all international factor portfolios display a statistically significant correlation with the US portfolios.Unlike asset classes, however, the correlations of factor portfolios across regions have not been increasing over the last two decades, making global equity factors a particularly desirable addition to a portfolio. Before we delve into our findings, we offer a brief overview of our methodology and data.Our analysis builds on the Fama and French (2016) five-factor model and complements it with the momentum factor of Carhart (1997). Value is book equity scaled by market capitalization. Momentum is determined by the cumulative return over the past 12 months, excluding the immediately previous month. Lastly, operating profitability is defined as total sales minus cost of goods sold, minus selling, general and administrative expenses, minus interest, all divided by total assets.