Understanding the drivers of portfolio risk
Knowing the level of risk in a portfolio is only part of the problem. Arguably it is even more important to know the sources of risk – what are the bets being taken – to decide whether they are intended and desirable or unintentional and in need of mitigation.
Broadly speaking there are two approaches to assigning portfolio risk to named sources of risk – based on how an asset is characterised or on how it behaves. For example, Anheuser Busch is categorised as a Belgian company so a portfolio with an overweight position in the stock could be considered to be taking a bet on Belgium. On the other hand, as a multi-national with significant manufacturing and sales operations across the globe, the stock price performance of Anheuser will be driven by global macro-economic developments. Hence, from a behaviour point of view, it would not be appropriate to map the exposure arising from the overweight in Anheuser to Belgium alone, but to show it as a multi-country risk.
EMA supplies both types of risk attribution.
Portfolio risk can be apportioned to categories – Country, Sector, Curve, Currency etc – by the aggregation of the proportion of risk attributable to each asset or exposure. The EMA system pre-categorises all assets, but also allows the user to define their own category sets.
EMA Style Analysis uses a regression technique to map asset and portfolio level risk to a set of system or user defined indices that represent different investment characteristics. For example, the SP500 could represent the US, the spot price of Brent might represent Energy, and a growth index could represent growth-style investing. The EMA system contains several sets of instruments (“styles”) that can be used in this analysis, or it is possible for the user to define their own universe of styles.
|Risk Attribution options||Examples||Can be user defined|
|By category||Allocation to Country, Sector, Currency, Curve|
|By market behaviour||Exposure to SP500, FTSE100, TOPIX, EUR, JPY, US Tsy 5yr, US Tsy 10yr, WTI, VIX|