Multi-Factor Risk Attribution Concept and Uses. CREDIT SUISSE AG, Mary Cait McCarthy, CFA, FRM August 29, 2012

Transcription

1 Multi-Factor Risk Attribution Concept and Uses

2 Introduction Why do we need risk attribution? What are we trying to achieve with it? What is the difference between ex-post and ex-ante risk? What is the multi-factor model for risk? What kinds of analyses can an end investor expect? What are the advantages and disadvantages of the multi-factor risk model? 2/11

3 Risk Budgeting Process Asset Owners Need Risk Estimates What is it? A quantitative, model-based process for allocating investment risk across portfolios or managers Step 1 Goal Setting What are the benefits? Provides a consistent, objective framework for decision making Helps to identify and quantify unintentional and unmanaged risks Reduces the cost of contracting Increases the latitude that managers have to add value Step 2 Risk Budget/ Asset Allocation Step 3 Manager Weighting/ Guidelines Step 5 Risk Management and Rebalancing Capital Market Assumptions Manager Forecasts Step 4 Portfolio Management 3/11

4 Risk Estimation and Attribution Goals and Uses Goals Understand the future riskiness of portfolio Based on current portfolio positioning Identify how decisions generate risk Identify how decisions interact with each other from a risk point of view Understand risk sensitivity to portfolio changes What problems do we need to solve to achieve our goals? How to measure risk How to attribute risk 4/11

5 What is Risk? Ex-post versus Ex-ante Assumption: risk is volatility => standard deviation of return Ex-post Backward-looking estimate Based solely on the time series of observed returns Completely ignores changes in portfolio positioning (i.e. weight in equity, duration of portfolio, existence of alternative asset classes) Ex-ante Forward-looking estimate Requires some kind of a model of portfolio and/or security returns Combines current portfolio positioning with observed variability of model drivers 5/11

6 Multi-Factor Model for Ex-Ante Risk Fundamental Factor Model Methodology Starting point is return Assumption: return (at security level) can be explained by a linear combination of exposure to systematic factors and their returns plus a security specific return Exposures to systematic factors can be measured at a given point of time Returns to systematic factors are estimated via a multiple linear regression return factors security, period exposure security, factor, begin _ period * factor _ return factor, period Examples of fundamental factors Equity factors: currencies, industries, fundamentals (size, style, momentum), countries Fixed income factors: yield curve factors, Euro country spreads, sector spreads, quality spreads Alternative factors: commodity type, real estate type, hedge fund strategy Return to risk Exposures remain unchanged Factor returns become a covariance matrix (volatility and correlation of factors) Multiplication becomes matrix math Specific return volatility can be ignored for large, diversified portfolios specific _ return security, period 6/11

7 An Example Overall Portfolio Level For illustrative purposes only, based on Wilshire Associates Risk Model 7/11

8 An Example Sub-asset Class/Manager Level For illustrative purposes only, based on Wilshire Associates Risk Model 8/11

9 An Example Manager Positioning Level Sources of Relative Risk Region Country Industry Fundamental Currency Covariance Specific Risk Fundamentals: Net Exposures and MCTE Log Market Cap E/P Ratio Book/Price Volatility Momentum Net Z-Score (bars) -2-3 Industry: Net Exposures and MCTE /11 Materials Utilities Energy-EE Food Bev. Tob. Pharma&Biotech Banks Insurance Semiconductors & Telecomm Services Capital Goods Software Real Estate Materials-EE Food & Staples Transportation Consumer Services Comm Services & Auto&Comp Health Eqpt & Srvcs Consumer Durables Retailing Household & Prsnl Energy Tech Hardware & Media Div. Financials Net Weight (bars) For illustrative purposes only, based on Wilshire Associates Risk Model

10 Why Choose a Multi-Factor Risk Attribution? Advantages and Disadvantages Advantages Full flexibility of attribution (grouping of factors) Asset class, sub-asset class, portfolio manager, manager positioning, security level Consistent methodology for risk budgeting decisions at all levels of investment process Current portfolio positioning is fully captured and reflected in risk estimates and attribution Disadvantages Need a multi-factor risk model Need extensive amounts of data For estimating model Security level data for exposure and returns Almost impossible to do without a dedicated system and know-how 10/11

11 Disclaimer This document was produced by Credit Suisse AG and/or its affiliates (hereafter ""CS"") with the greatest of care and to the best of its knowledge and belief. However, CS provides no guarantee with regard to its content and completeness and does not accept any liability for losses which might arise from making use of this information. The opinions expressed in this document are those of CS at the time of writing and are subject to change at any time without notice. If nothing is indicated to the contrary, all figures are unaudited. This document is provided for information purposes only and is for the exclusive use of the recipient. It does not constitute an offer or a recommendation to buy or sell financial instruments or banking services and does not release the recipient from exercising his/her own judgment. The recipient is in particular recommended to check that the information provided is in line with his/her own circumstances with regard to any legal, regulatory, tax or other consequences, if necessary with the help of a professional advisor. This document may not be reproduced either in part or in full without the written permission of CS. It is expressly not intended for persons who, due to their nationality or place of residence, are not permitted access to such information under local law. Neither this document nor any copy thereof may be sent, taken into or distributed in the United States or to any U. S. person (within the meaning of Regulation S under the US Securities Act of 1933, as amended). Every investment involves risk, especially with regard to fluctuations in value and return. Investments in foreign currencies involve the additional risk that the foreign currency might lose value against the investor's reference currency. It should be noted that historical returns and financial market scenarios are no guarantee of future performance. Copyright 2012 Credit Suisse Group AG and/or its affiliates. All rights reserved. 11/11