Systematic risk premia investing

Published в Can slim investing reviews for horrible bosses | Октябрь 2, 2012

systematic risk premia investing

Systematic strategies can be an efficient way to gain access to long-term diversified sources of alpha within portfolios. They aim to take. Keywords: Alternative risk premium, factor investing, skewness risk, market anomalies, systematic risk factor, diversification, carry, momentum, value. The terms alternative risk premia, systematic premia, style premia and factor strategies are used interchangeably, and refer to the fact that. AFFILIAZIONI FOREX

On the other hand, as we have advocated, achieving true risk diversification should be the primary goal of ARP portfolio construction. For some, this means that a reduced allocation to value may be warranted from a risk control standpoint, though this does not mean that investors should go to the other extreme and assign value an unrealistically low ex ante Sharpe ratio. Dramatic shifts in factor weights due to recent performance can be just as risky.

Our view has been, and continues to be, that equity value is one of many alternative risk premia strategies that can provide returns and diversification within a well-constructed ARP portfolio. In terms of key positive contributors to performance in the first quarter, ARP strategies that would logically be expected to do well under these stress circumstances generally fulfilled their purpose. Value and carry premia strategies in interest rate markets captured not only the large decline in yields, but also the long-predicted convergence between U.

These strategies also benefited on the backend of the crisis from dislocations across sovereign yield curves see Figure 2. As began to look like a rerun of , trend-following strategies moved toward defensive positions: short equities, long interest rate duration, short energy, and long the U. These exposures helped to reduce losses, at least until markets turned sharply at the end of March.

Faster trend-followers, which are designed to be more reactive, performed strongly on the way down and managed to lock in a good proportion of the profits through the rebound — behaving exactly as anticipated see Figure 4. Slower trend-followers which had optimized to maximize capacity, turned more slowly, likely becoming short around the market bottom in March, and staying so through much of the second-quarter rebound.

In summary, the events of the first quarter of affected ARP strategies in various ways. For strategies that sought to harvest procyclical risk premia, one may have reasonably expected losses during periods of market stress, though implementation details tend to have a huge impact on the outcome. On the other hand, countercyclical strategies can benefit from these episodes, and indeed can be constructed to do so at the cost of forgoing some performance in the good times.

Other, more idiosyncratic strategies can be subject to spillover effects, and understanding the dynamically varying correlations of these strategies and making them as robust as possible to outcomes, perhaps even beyond the range of reasonable expectations, is essential to their viability going forward, in our view.

Above all, diversification is key in making sure that one maintains a sensible blend of risk-on and risk-off strategies and ensuring that no single factor or strategy dominates portfolio risk. Importantly, although diversification does not preclude drawdowns, a diversified portfolio, on average, is more likely to outperform a concentrated portfolio and deliver higher risk-adjusted returns over the long run.

For example, the FX carry strategy incorporates value factors thus reducing exposure to high carry but overvalued currencies and uses an optimization technique that constrains equity correlation. The two versions of our ARP strategy recognize the trade-off between defensiveness and long-term return potential.

MAARS is a combination of systematic strategies that seeks to maximize estimated Sharpe ratio with near-zero long-term equity beta, while MAARS ROVER is a combination that adjusts underlying strategies to enhance defensiveness at the cost of some long-term return potential.

Some of our strategies may resemble those targeting traditional ARP factors, such as carry, short volatility, or equity value. But many others are akin to the dynamic alpha opportunities pursued by hedge funds, which are conceptually different from static ARP strategies that most allocators are more familiar with. Our portfolio construction is built around the importance of diversification.

We avoid taking outsize risks in any individual factor or asset class. As a result, the portfolio has benefited from having more exposure to high conviction strategies outside of equities and from less exposure to mainstream equity factors that have underperformed. We have extensive experience in fixed income, commodity, and currency strategies relative to some of our peers who generally focus on equities or trend-following.

These capabilities and resources also allow us to supplement the more common ARP strategies with other proprietary systematic sources of returns. Finally, we believe continuous innovation and development are crucial for quantitative strategies, both in terms of implementing new systematic strategies and improving existing ones. Our ARP portfolios have evolved over time and PIMCO continues to invest heavily in quantitative resources, technology, and innovation as a strategic priority.

Conclusion Systematic quantitative strategies can be an efficient way to seek long-term diversified sources of alpha within portfolios. In search of these characteristics, many investors took on allocations to alternative risk premia strategies. Performance in affected ARP strategies in many different ways, but wide performance dispersion underscores the importance of portfolio construction and continuously researching new sources of alpha, constantly refining models, adding new and diversifying markets, and responding appropriately to changing market conditions.

Summary Alternative risk premia ARP strategies can be an efficient way to gain access to long-term diversified sources of alpha within portfolios but have been in the spotlight lately due to performance headwinds. Smart beta and alternative risk premia investing bring many years of academic research to investors, with both approaches helping investors to capture sources of extra return stemming from risk factors such as value, carry, quality, and momentum. Most investors are well aware of traditional risk premia such as the equity risk premium, which is the reward associated with investing in equity markets.

The term premium — the reward investors receive from the added risk of owning longer-term bonds — and the credit premium — the reward investors obtain from holding riskier bonds issued by entities other than governments — are also understood by many. Alternative risk premia are systematic sources of return that arise after breaking down an asset class such as equities into common drivers of return supplementary to the market beta, the traditional equity risk premium. Some alternative risk premia can be viewed as risk premia in a strict sense, while others can only be viewed as market anomalies.

Many categorize alternative risk premia into two camps: skewness risk premia or pure risk premia, which stem from size or value risk factors; and market anomalies, risk factors stemming from behavioral biases. However, this distinction is not always completely objective as some risk factors can be viewed as both risk premia and market anomalies. One example of alternative risk premia is the so-called cross-section momentum equity risk premium, which can be harvested by going long on past best-performing stocks and short on past worst-performing stocks.

The carry currency risk premium serves as another example. The premium can be exploited by going long on the currencies of countries with high interest rates and short currencies of the countries with low interest rates. Carry, value, and momentum are considered by Amundi as the most relevant alternative risk premia as they are present across all asset classes.

Trend — also called the cousin of momentum and the prime strategy of CTAs — is another popular one. Short volatility strategies are also factor risk premia, but are not always included in portfolios due to their riskier nature. Same, Same, but Different These alternative risk premia represent the raw material used to build smart beta and alternative risk premia strategies. Alternative risk premia and smart beta can sometimes, mistakenly, be lumped together and used interchangeably, but there are a number of important distinctions between the two.

Whereas smart beta is usually captured using long-only investment strategies, alternative risk premia are harvested using more complex long-short strategies, sometimes market-neutral strategies. But perhaps the main distinction between the two hinges on the fact that smart beta strategies have exposure to both traditional and alternative risk premia. A value-oriented smart beta portfolio, for instance, will be fully invested in a basket of value stocks with high book-to-market ratios, which have been found to provide higher returns at lower risk compared to growth stocks , which means the long-only smart beta portfolio will exhibit a fairly high degree of correlation to equity markets.

The exposure to the value risk premia, however, will be partial only. By eliminating the effect of market directionality, alternative risk premia products provide a purer exposure to the return potential of the risk premium stemming from value. The graph below sketches the relation between traditional risk premia, alternative risk premia, and smart beta strategies.

Both alternative risk premia and smart beta investing have their own merits, and one can find a role for both strategies in the same portfolio.

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For instance, a well-managed company that adheres to environmental and social regulations is less likely to face litigation, the higher costs associated with the management and disposal of hazardous waste and elevated employee injury rates. Therefore, ESG factors may provide better insight into the probability distribution of company returns in the same way as the traditional risk premia incorporated in classical asset pricing frameworks.

Also, ESG factors are strong candidates for inclusion in long-term factor investing. They display strong explanatory power over a wide range of securities, offer a positive payoff over reasonably long horizons, have a significantly low correlation with other factors and, above all, they make intuitive and economic sense. In identifying ESG factors as risk premia, the systematic investor needs to move beyond traditional screening methodologies and policy implementation towards a rules-based, scalable and measurable ESG integration strategy.

To do so requires practical, quantifiable metrics that can be readily integrated into an existing investment process, together with other strategies to construct a well-diversified portfolio. To this end, we have developed the Prescient ESG Scorecard which is an in-house risk analysis tool designed to evaluate and measure the ESG risks and opportunities associated with the credit and equity counterparties in which we invest. It is a data-driven and systematic scorecard that rates companies relative to their sector-specific peers while accounting for industry materiality and market cap biases.

We employ over 60 metrics to gain granular insights into the proficiency of the ESG practices of the underlying counterparties. Each of the metrics is conscientiously identified and selected to address a broad range of globally recognised material ESG themes. These themes include board and workforce diversity, board structure, water usage, greenhouse gas emissions and the safety of employees, to name a few.

A combination of extensive ESG research, active engagement with our investees and this cross-sectional scoring tool has significantly enhanced our ability to integrate ESG into our investment process alongside the traditional risk premia we consider. It also enables us to interrogate practices that historically eluded systematic investors. The last decade has seen ESG find a permanent place in everyday investing. We accomplish these two goals by managing absolute and relative downside financial risk, as well as non- financial operating risk.

Full Bio Pete Rathburn is a freelance writer, copy editor, and fact-checker with expertise in economics and personal finance. He has spent over 25 years in the field of secondary education, having taught, among other things, the necessity of financial literacy and personal finance to young people as they embark on a life of independence.

Learn about our editorial policies What Is Systematic Risk? Systematic risk refers to the risk inherent to the entire market or market segment. Key Takeaways Systematic risk is inherent to the market as a whole, reflecting the impact of economic, geopolitical, and financial factors. This type of risk is distinguished from unsystematic risk, which impacts a specific industry or security.

Systematic risk is largely unpredictable and generally viewed as being difficult to avoid. Investors can somewhat mitigate the impact of systematic risk by building a diversified portfolio. Understanding Systematic Risk Systematic risk is both unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the correct asset allocation strategy.

Systematic risk underlies other investment risks, such as industry risk. If an investor has placed too much emphasis on cybersecurity stocks, for example, it is possible to diversify by investing in a range of stocks in other sectors, such as healthcare and infrastructure. Systematic risk, however, incorporates interest rate changes, inflation, recessions, and wars, among other major changes. Shifts in these domains can affect the entire market and cannot be mitigated by changing positions within a portfolio of public equities.

To help manage systematic risk, investors should ensure that their portfolios include a variety of asset classes, such as fixed income, cash, and real estate, each of which will react differently in the event of a major systemic change. An increase in interest rates , for example, will make some new-issue bonds more valuable, while causing some company stocks to decrease in price as investors perceive executive teams to be cutting back on spending.

In the event of an interest rate rise, ensuring that a portfolio incorporates ample income-generating securities will mitigate the loss of value in some equities. Systematic vs. Unsystematic Risk The opposite of systematic risk is unsystematic risk which affects a very specific group of securities or an individual security. Unsystematic risk can be mitigated through diversification.

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