Compensated and Uncompensated Risks in Global Factor Investing

Global equity risk factors that are constructed by sorting stocks on firm characteristics associated with expected returns contain embedded region and sector exposures. The authors show that these positions lead to uncompensated volatility. Hedging out both region and sector exposures <italic>simultaneously</italic> increases the Sharpe ratio of the typical global factor by 50%. Hedged factors, individually or in a model, always subsume their nonhedged counterparts. The results have implications for international asset pricing and portfolio management.