Understanding Risk Factors in a Multi-Asset Class Portfolio
Building a resilient portfolio that can deliver strong returns and weather turbulent markets is the core responsibility for all institutional asset owners. The traditional approach to this process revolves around setting allocation targets for each segment of the portfolio and allocating capital accordingly.
A typical institutional investor’s allocation mix might look something like this:
Sample Asset Allocation Mix
| Asset Class | Target Allocation Range | Current Allocation |
|---|---|---|
| Public Equity | 50 - 60% | 57.3% |
| Fixed Income | 10 - 20% | 17.4% |
| Real Estate & Real Assets | 10 - 15% | 15.6% |
| Private Markets | 5 - 10% | 9.7% |
With allocation targets set, asset owners proceed to evaluate and commit to funds to build out their portfolios until each individual asset class allocation is in the appropriate range. The cycle of monitoring, evaluation, and commitments continues indefinitely as the portfolio grows, investments wind down, and targets are tweaked.
While this approach to portfolio allocation ensures that it is properly diversified along set allocation targets, it provides little insight into the risk profile of the portfolio. Despite their different asset classes, various types of investments can be affected by risk factors in the same way. While a portfolio might look diversified from an asset allocation profile, an asset owner may be unwittingly exposing their portfolio to extensive systematic risk.
Analyzing a portfolio based on risk factors offers asset owners a new perspective on their portfolio and can reveal where they may be taking on too much, or too little risk. A regression-based factor risk model is the second of two types of risk modeling employed by Solovis, Nasdaq’s multi-asset portfolio analytics platform. The factor-based model is designed to capture the interaction and overlap of risk within an asset owner’s portfolio.
The default model in Solovis relies on nine key factors:
| Risk Factor | Default Model Representative Index |
|---|---|
| Market | MSCI ACWI Total Return |
| Rates | Bloomberg Barclays US Treasury 20+ Total Return |
| Spreads | Long ICE US Corporate Index / Short Bloomberg Barclays US Treasury 7-10 Year |
| Commodities | S&P GSCI Total Return |
| Currencies | USD Index |
| Value (equity style) | Long MSCI ACWI Value / Short MSCI ACWI Growth |
| Momentum (equity style) | Long MSCI ACWI Momentum / Short MSCI ACWI |
| Quality (equity style) | Long MSCI Quality / Short MSCI ACWI |
| Size (equity style) | Long MSCI ACWI Small Cap / Short MSCI ACWI Large Cap |
The four equity style factors are each a custom index created from long-short pairs to isolate the factor's impact on the market and reduce collinearity in the return series.
While these factors serve as defaults, the model is a flexible one that allows asset owners to customize their factors based on the portfolio they are analyzing.
For example, when looking at a healthcare focused equity manager, it would make sense to add a sector-specific factor to assess the beta to healthcare in the portfolio. Learn more about how Nasdaq Solovis is helping institutional investors understand their portfolio risk in our latest whitepaper, Do You Know What's Driving Your Portfolio Risk?
Use the link below to access the paper.
Do You Know What’s Driving Your Portfolio Risk?
Dive deeper in this new whitepaper to learn how risk factors affect multi-asset class portfolios for institutional investors.
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Andres Ramos
Nasdaq
Andres Ramos is a specialist at Nasdaq focused on the world of institutional investing.
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