Asset managers – equity

Flexible and intuitive risk attribution

It is non-trivial to get an understanding of the systematic factors that may be the key sources of risk in an equity portfolio.

For a tracker or near-tracker fund, knowledge of the beta may be sufficient to know what is likely to drive future relative returns.

However, once the manager starts to carry out stock-picking and/or makes country, sector and fundamental bets, which of those become the most influential on expected relative returns is not easy to surmise.

It is in the nature of equity securities that they each represent a unique bundle of exposures to countries, sectors and fundamentals as well as having certain characteristics that no other company shares.

Categorising a company as “American” or “Chinese” is only part of the story. Many will, for example, manufacture in one country and market in the other. Similarly, with sector definitions and fundamental scores. Not all “financials” are equal and P/E has a very different meaning for a cyclical as opposed to a growth stock.

The EMA system looks behind these characterisations to how fund managers – the market – actually treat each stock. If it performs as though it is half American and half Chinese, that will drive its risk factor exposures.

At the portfolio level, the system then adds up all the exposures, netting them off against a benchmark if applicable. The reporting of the exposures can then be shown in relation to any definition of investment themes as determined by the user. For example, if the Russell 3000 is considered a better representation of “exposure to US equities” than the S&P500, then the system will report the proportion of risk attributable to it and not the S&P500.

Combined with the ability to design custom reports, the EMA system is particularly attractive to equity managers because it can be tailored to the manager’s investment approach. This helps the firm both to confirm the risk profile of its portfolios and to communicate to clients that the investment strategy being deployed is consistent with the mandate.