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The Current Risk Landscape
Axioma Insight Findings Q3 and October 2015 Melissa R. Brown, CFA
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What is Risk? VIX is One Measure
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Average since 1999 Source: Yahoo! Finance, STOXX, Axioma Inc.
0
10
20
30
40
50
60
70
80
90
100
2007 2008 2009 2010 2011 2012 2013 2014 2015
VIX VIX Average VSTOXX VSTOXX Average
1015202530354045
Jan FebMar Apr May Jun Jul Aug Sep Oct Nov
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What is Risk? Sample of Other Measures
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• Value at risk
• Downside risk • Interest rate/credit risk
• Liquidity risk
• Reinvestment risk
• Inflation risk
• “Knowing your companies”?
• …
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Axioma’s Risk: We Focus on Quantifiable Risks
Risk (Financial) Expected volatility (of a market, portfolio, etc.) over a predefined investment horizon Risk Management “The process of identification, analysis and either acceptance or mitigation of uncertainty in investment decision-making” Investopedia
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Axioma Risk Models
• Axioma’s standard product includes 4 risk models per region – 14 countries/regions/global
• By factor structure – Fundamental: uses predefined set of factors, such as country,
industry, currency, style – Statistical: “lets the data speak”
• By horizon – Short horizon: 1 to 2 month forecast – Medium horizon: 3 to 6 month forecast
• In addition, there is a macroeconomic model for the US • Underlying each model is a set of volatilities and correlations, so we can
“peel the onion” and see what is driving market risk – Major components: Market, Industry, Style, Country, Currency, Stock
Specific • Used to measure total risk and active risk
5 © Copyright, Axioma, Inc. 2015. All rights reserved.
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Today’s Discussion
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• Style factor returns
• How risk models reacted to August downturn and subsequent volatility
• Comparison of benchmarks
• What drove changes in risk: countries, currencies, etc.
• Small vs. large, emerging vs. developed
• Impact of correlations on risk
• China • Asset class correlations
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Source: Axioma Inc.
Factor Performance: Momentum and Value
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-4
-2
0
2
4
6
8
10
12
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
Momentum
US CA EU AP
JP AU WW EM
-6
-4
-2
0
2
4
6
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
Value
US EU AP JP
AU WW EM CA
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Source: Axioma Inc.
Factor Performance: Volatility and Growth
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-16
-14
-12
-10
-8
-6
-4
-2
0
2
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
Volatility
US EU AP JP
AU WW EM CA
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
Exchange Rate Sensitivity
US EU AP JP WW EM
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Benchmark Risk
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• How quickly risk models reflected market downturn
• Current risk by region
• Changes over time
• Major drivers
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Models Reacted Quickly to Market Drops
© Copyright, Axioma, Inc. 2015. All rights reserved. 10
-12%
-8%
-4%
0%
4%
8%
8%
12%
16%
20%
24%
Dec-14 Feb-15 Apr-15 Jun-15 Aug-15
Russell 1000
-6%
0%
6%
12%
18%
24%
10%
14%
18%
22%
26%
30%
Dec-14 Feb-15 Apr-15 Jun-15 Aug-15
FTSE Developed Europe -8%
-4%
0%
4%
8%
12%
16%
20%
24%
10%
14%
18%
22%
26%
30%
Dec-14 Feb-15 Apr-15 Jun-15 Aug-15
FTSE Japan
-24%
-16%
-8%
0%
8%
16%
10%
12%
14%
16%
18%
20%
22%
24%
Dec-14 Feb-15 Apr-15 Jun-15 Aug-15
FTSE Asia Pac ex-Japan -8%
-4%
0%
4%
8%
8%
10%
12%
14%
16%
18%
20%
22%
Dec-14 Feb-15 Apr-15 Jun-15 Aug-15
FTSE Developed -24%
-16%
-8%
0%
8%
16%
10%
12%
14%
16%
18%
20%
22%
24%
26%
Dec-14 Feb-15 Apr-15 Jun-15 Aug-15
FTSE Emerging
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Source: FTSE, Axioma Inc.
How Does Current Risk Look Relative To History?
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0%
10%
20%
30%
40%
50%
60%
2007 2008 2009 2010 2011 2012 2013 2014 2015
FTSE Global Developed Index
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US Small Cap Risk Is Lower Than Large Cap
12 © Copyright, Axioma, Inc. 2015. All rights reserved.
Source: FTSE, Russell Investments, Axioma Inc.
0.8
0.9
1
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
2007 2008 2009 2010 2011 2012 2013 2014 2015
Russell 2000 vs. Russell 1000 Risk
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Currency Risk Was Generally Up in Q3, But Has Reversed QTD
13 Source: Axioma, Inc.
Developed Market Currency Volatility (vs. USD)
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-15%
-10%
-5%
0%
5%
10%
15%
20%
EUR DKK JPY CHF SGD SEK GBP NZD NOK AUD CAD
Change in Risk
Q4 through 05-Nov-2015
Q3 2015
Q2 2015 0%
2%
4%
6%
8%
10%
12%
14%
NOK NZD EUR DKK CHF SEK AUD JPY CAD GBP SGD
Risk Level 05-Nov-2015
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Risk Also Rose For Most Countries
14 Source: Axioma, Inc.
Change in Extra-Market Country Volatility: Developed
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-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
Q4 through 05-Nov-2015 Q3 2015 Q2 2015
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Australia’s Extra-Market Risk Has Climbed
15 Source: Axioma, Inc. © Copyright, Axioma, Inc. 2015. All rights reserved.
0%
2%
4%
6%
8%
10%
12%
14%
16%Risk Level 05-Nov-2015
0%
50%
Greece
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Yield Curves Have Shifted Down Since June
© Copyright, Axioma, Inc. 2015. All rights reserved. 16 Source: Markit, Axioma, Inc.
0.00%
1.00%
2.00%
3.00%
4.00%
0 10 20 30
US
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
0 10 20 30
Canada
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
0 10 20 30
UK
-0.50%
0.00%
0.50%
1.00%
1.50%
2.00%
0 10 20 30
Germany
-0.50%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
0 10 20 30
France
-1.00%
0.00%
1.00%
2.00%
3.00%
4.00%
0 10 20 30
Spain
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Risk For Most Currencies Rose in Q3, But None Like CNY (Still the Lowest Level of Risk)
17
Source: Axioma, Inc. © Copyright, Axioma, Inc. 2015. All rights reserved.
Emerging Market Currency Volatility (vs. USD)
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
BRL TWD INR THB MXN ZAR IDR TRY RUB
Change in Risk
Q4 through 05-Nov-2015 Q3 2015 Q2 2015
-50%0%
50%100%
CNY
0%
5%
10%
15%
20%
25%
RUB BRL ZAR TRY MXN IDR THB INR TWD CNY
Risk Level 05-Nov-2015
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China Has Become the Most Volatile EM Country…
18 Source: Axioma, Inc.
© Copyright, Axioma, Inc. 2015. All rights reserved.
0%
5%
10%
15%
20%
25% Risk Level 05-Nov-2015
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Q2 Saw The Biggest Increase of China’s Risk
19
Source: Axioma, Inc.
Change in Extra-Market Country Risk: Emerging
© Copyright, Axioma, Inc. 2015. All rights reserved.
-30%
-10%
10%
30%
50%
70%
90%
110%
130%
150%Q4 through 05-Nov-2015 Q3 2015 Q2 2015
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Managing China’s Risk Continues to be Challenging
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0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
10/19/2015 9/17/2015 6/30/15 12/31/2014
China's Role in FTSE Emerging Markets
Capitalization Weight Percent of Risk
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EM Risk is Currently More Diverse
21 © Copyright, Axioma, Inc. 2015. All rights reserved.
Source: Axioma Inc.
-25%
-15%
-5%
5%
15%
25%
35%
0% 10% 20% 30% 40% 50%
June 30, 2015 DevelopedEmergingAverage DevelopedAverage Emerging
Greece
China
-25%
-15%
-5%
5%
15%
25%
35%
0% 10% 20% 30% 40% 50%
November 5, 2015 DevelopedEmergingAverage DevelopedAverage Emerging
Greece
China
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EM Risk Recently Rose Sharply in H1 But Then Settled Down Relative to DM
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Source: FTSE, Axioma Inc.
Emerging vs. Developed Risk
0.5
0.7
0.9
1.1
1.3
1.5
1.7
1.9
2007 2008 2009 2010 2011 2012 2013 2014 2015
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Brazil’s Yield Curves Shifted Up
© Copyright, Axioma, Inc. 2015. All rights reserved. 23 Source: Markit, Axioma, Inc.
10.00%
11.00%
12.00%
13.00%
14.00%
15.00%
0 10 20 30
Brazil
9.00%
9.50%
10.00%
10.50%
11.00%
0 10 20 30
Russia
6.50%
7.00%
7.50%
8.00%
8.50%
0 10 20 30
India
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
0 10 20 30
China
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Equity Markets Were Positively Correlated With Each Other – And With Bonds…
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Q3 Realized Correlations
-1 0 1
Russell 1000FTSE Dev Europe
FTSE Asia Pac…FTSE Japan
FTSE DevelopedFTSE Emerging
GBPEURJPY
GBP Gov.10YUSD Gov.10YJPY Gov.10Y
EUR Gov.10YBrent Crude
Gold
Russell 1000
-1 0 1
FTSE Dev Eur
-1 0 1
FTSE AP ex JP -1 0 1
FTSE Japan -1 0 1
FTSE Emerg
-1 0 1
GBP
-1 0 1
EUR
-1 0 1
JPY -1 0 1
Russell 1000FTSE Dev Europe
FTSE Asia Pac…FTSE Japan
FTSE DevelopedFTSE Emerging
GBPEURJPY
GBP Gov.10YUSD Gov.10YJPY Gov.10Y
EUR Gov.10YBrent Crude
Gold
USD Gov.10Y
-1 0 1
GBP Gov.10Y
-1 0 1
EUR Gov.10Y
-1 0 1
JPY Gov.10Y
-1 0 1
FTSE Devel
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…But Correlations Changed A Lot Recently
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Change in Correlation From Q2
-1 0 1
Russell 1000FTSE Dev Europe
FTSE Asia Pac…FTSE Japan
FTSE DevelopedFTSE Emerging
GBPEURJPY
GBP Gov.10YUSD Gov.10YJPY Gov.10Y
EUR Gov.10YBrent Crude
Gold
Russell 1000
-1 0 1
FTSE Dev Eur
-1 0 1
FTSE AP ex JP
-1 0 1FTSE Japan
-1 0 1FTSE Emerg
-1 0 1
GBP
-1 0 1
EUR
-1 0 1
JPY -1 0 1
Russell 1000FTSE Dev Europe
FTSE Asia Pac…FTSE Japan
FTSE DevelopedFTSE Emerging
GBPEURJPY
GBP Gov.10YUSD Gov.10YJPY Gov.10Y
EUR Gov.10YBrent Crude
Gold
USD Gov.10Y
-1 0 1
GBP Gov.10Y
-1 0 1
EUR Gov.10Y
-1 0 1
JPY Gov.10Y
-1 0 1FTSE Devel
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Source: FTSE, Russell Investments, Standard and Poor’s China Securities Index Company Ltd., Axioma Inc.
Asset Correlations Shot Up Sharply Globally…
© Copyright, Axioma, Inc. 2015. All rights reserved. 26
FTSE Global Developed
FTSE Emerging
Median realized correlations Percent of correlations that were negative
Percent of correlations that were negative Median realized correlations
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.50
2000 2002 2004 2006 2008 2010 2012 20140%
5%
10%
15%
20%
25%
30%
35%
40%
45%
2000 2002 2004 2006 2008 2010 2012 2014
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
2000 2002 2004 2006 2008 2010 2012 20140%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
2000 2002 2004 2006 2008 2010 2012 2014
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Source: FTSE, Russell Investments, Standard and Poor’s China Securities Index Company Ltd., Axioma Inc.
…But Slightly Less in Large-Cap US
© Copyright, Axioma, Inc. 2015. All rights reserved. 27
Median correlations
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
2000 2002 2004 2006 2008 2010 2012 2014
Russell 1000
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
2000 2002 2004 2006 2008 2010 2012 2014
Russell 2000
0%
5%
10%
15%
20%
25%
30%
35%
40%
2000 2002 2004 2006 2008 2010 2012 2014
Percent of Correlations That Were Negative
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High Correlations Can Theoretically Benefit Some Strategies While Hurting Others
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Some “rules of thumb” regarding correlation and risk. These won’t always be observed in practice, but all other things being equal, as correlations increase… • Total risk of long only portfolios tends to increase
• Total risk of 100% long-short (dollar neutral) portfolios tends to decrease
The short positions become a better hedge for the long positions
• Total risk of 130/30 portfolios tends to increase
The decrease in the long-short portion of the portfolio is dominated by the increase in the long only portion
• Active risk tends to decrease
Active positions around a benchmark form a long-short portfolio
• The diversification benefit of adding more stocks decreases
• Portfolios will have a higher proportion of factor risk (and a lower proportion of stock-
specific risk)
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Source: FTSE, Russell Investments, Standard & Poor's, China Securities Index Company, Ltd, Axioma Inc.
Q3 Asset Dispersion Was Generally Higher Than Average (Good News for Stock Pickers!)
29 © Copyright, Axioma, Inc. 2015. All rights reserved.
0%
2%
4%
6%
8%
10%
12%
14%
Russell 1000 Russell 2000 FTSEDeveloped
Europe
FTSE AsiaPacific
FTSE Japan CSI 300 ASX 200 FTSEDeveloped
FTSEEmerging
Average Monthly Asset Dispersion Q3 2015 Q2 2015
Q1 2015 Long-Term
0%
1%
2%
3%
4%
US Europe Asia ex-Japan Japan China Australia Worldwide Emerging
Average Monthly Style Factor Dispersion
Q3 2015 Q2 2015
Q1 2015 Long-Term
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7 Key Takeaways for Portfolio Managers
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• Style factor investing has been challenging
• US small caps now less risky than large cap
• Currency and country risks have changed, some dramatically • Emerging market risk has become more disperse
• Correlations have changed substantially
• China presents risk challenges • Cross asset-class correlations have moved
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Daily Risk Monitors
• We provide daily risk monitors for – US – Canada – UK new – Europe – Asia-Pacific ex-Japan – Japan – China – Australia – Taiwan – Emerging Markets – Global Developed
• Look on www.axioma.com for daily updates of this data • Sign up to get a weekly reminder about the reports
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Major Themes
• Risk rose since the end of Q2, doubling or more for most benchmarks – TSX Composite, ASX 200 had lowest risk of the major benchmarks we track – Russell 2000 risk fell below that of Russell 1000
• Factor performance varied widely by region, and some factors had returns that fell into the top or bottom percentiles relative to history – Momentum fell apart after quarter-end, with the worst 5-day period ever for the
EU, WW and JP models at one point in the first half of October – At the same time Volatility had among its highest returns (contrary to
expectations) across most regions. During the market downturn in August returns to Volatility were extremely negative in most parts of the world.
• Emerging market risk shot up earlier in Q3, but recently developed markets saw bigger increases, and dispersion in risk across emerging markets has increased
• China’s risk ballooned this year, and its changing proportion of benchmark risk has presented challenges for managers investing in China
• Asset correlations have increased substantially, in some cases to higher levels than during the financial crisis -- meaning more total risk, more factor risk, probably less active risk all other things equal
• Changes in the components of risk (correlations, volatility, and specific factors like emerging vs. developed, small vs. large and currency markets) meant big changes in active risk as well
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Contact Us For more information on any of these slides or any of Axioma’s other offerings, please contact your account representative or [email protected] I can also be reached at [email protected] or 212-991-4507
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