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The Volatility Factor and Risk Aversion
This article examines how Barra factors can be used to better understand the market environment. We analyze the 2011 equity markets and observe the performance of some Barra factors during market events. We also investigate relationships between the returns to the Barra Volatility1 factor and the levels of implied volatility, as measured by the CBOE Volatility Index (VIX). The factors that we focus on are defined in the Barra Global Equity Model (GEM2), a global multi-factor risk model used by fund managers to help construct and manage global equity portfolios. Read more.
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Options for Choosing Risk Aversion in Active Portfolio Construction - A Practical Approach
Balancing expected return and risk during portfolio construction...
Continue reading Options for Choosing Risk Aversion in Active Portfolio Construction - A Practical Approach
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The Impact of Constraints on Portfolio Construction and Optimization
The classic active mean variance optimization problem, without constraints, has a unique analytical solution that can be computed easily. However, portfolio managers can rarely work in a constraint-free environment. The full set of solutions is not often explored because the feasible region may be restricted due to constraints. The optimizer might be missing a solution with higher utility located outside the feasible region spanned by the constraints.
Continue reading The Impact of Constraints on Portfolio Construction and Optimization
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What a Difference a Day Makes
Stacy Cuffe, MSCI Consultant
On Monday August 8, 2011, Standard & Poor's downgraded the United States' credit rating, spawning a sell-off that left markets reeling and as such, has been recorded as the worst single day on Wall Street since the autumn 2008 crisis. Throughout the remainder of the month, mounting fears that there would be a US recession coupled with ongoing concern over European sovereign debt, leading investors to dramatically reduce risk exposure by unloading equities. In times like these, when a single tumultuous event takes place, it serves as a catalyst for a period of extreme market volatility with rapidly unfolding dynamics; and there is undeniable value in ensuring risk model inputs are updated daily.
Continue reading What a Difference a Day Makes
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Active Portfolio Construction with Barra Aegis when Risk and Alpha Factors are Misaligned
Ralph Karels, MSCI Consultant, has held a series of webinars throughout Europe highlighting risk and alpha misalignment. Below is an overview of his recommendations and advice on how to overcome this misalignment problem in portfolio construction.
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Mitigating Risk Forecasting Biases of Optimized Portfolios
How can we mitigate the effects of sampling error in portfolio optimization?
Portfolio managers have long suspected that the risk forecast of an optimized portfolio tends to be optimistic. Many have identified the culprit as estimation error in the covariance matrix. Forecasts based on historical asset covariance matrices are particularly sensitive to this error. The bias is reduced dramatically by using a factor model. Even so, factor models still tend to under-forecast the risk of optimized portfolios, especially the risk coming from factors.
Continue reading Mitigating Risk Forecasting Biases of Optimized Portfolios
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Got Quant?
During the week of 12 September, the London Quant Group celebrated its 25th Anniversary in Oxford with a four-day program that touched on all facets of investing. Lectures ranged from the erudite "A General Theory of Risk and Return" to the client-centric "What is the Use of Performance Measurement" to the defiant "The 10 Biggest Myths in Asset Management." (Myth 5: Diversification Did Not Work During the Credit Crisis: It Did.) MSCI's Lisa Goldberg presented "Can Tail Risk Be Hedged," which highlights the role of the investment horizon in determining a tail risk hedging policy, and the dangers of skew to investors at all horizons.
For more information on upcoming LQG events, click here.
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I'm listening... what is my risk model saying?
Do my style factors have meaning?
Chris Shepler, CFA
Imagine this: the chief investment officer picks up the phone to the portfolio manager of a deep value fund to ask why, according to the latest risk report, the fund has negative exposure to the value factor. Sound crazy? It could happen.
Continue reading I'm listening... what is my risk model saying?
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Shifting Realities: Myths & Models SURVEY - The Results
MSCI is conducting a series of confidential surveys with portfolio managers and institutional investors over the next few months, covering many of the key issues faced in the industry today.
The first survey, “Shifting Realities: Myths & Models,” was published in July 2011 to gain a better understanding on the view of portfolio managers and institutional investors and best practices in the portfolio construction process. It concluded in August and the results were tallied.
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Does Style Make the Sector?
Style factor contributions to European sector returns
In our recent webinar, MSCI research experts, Oleg Ruban and Zoltan Nagy reviewed the contribution of style factors, such as Value, Growth and Momentum among others, to the performance of European sector portfolios using the enhanced Barra Europe Equity Model (EUE3). They discussed sector rotation strategies and highlight the advantages of examining the style exposures within each sector. Styles play an important role in sector performance, and returns driven by style effects can dominate returns due to industry membership. Results examined in their recent paper, Does Style Make the Sector? suggest that the analysis of the style profile of a sector can help in implementing a superior sector rotation strategy.
Continue reading Does Style Make the Sector?