Understanding Investing

The Benefits of Risk Factor Investing

Steve Sapra, senior member of the client solutions and analytics team, explains how a focus on risk factors can simplify investors’ ability to assess the risk/return profile across asset classes and sectors.

More from this section

Read Transcript

Justin: Steve, you mentioned our risk factor approach to investing. Can you elaborate on what you mean by that?

Steve: Sure. Well, think about the, uh, think about the fixed income space and the number of indices that are in the fixed income space. You have. You have treasury indices. You have corporate bond indices. You have high-yield indices. You have indices that focus more on mortgages. You obviously have domestic. You have global, uh, global indices.

But what's really key is that all of these different indices are only exposed to a handful of what we call risk factors — in other words, the primary drivers of risk and return. For example, uh, all of the benchmarks that I just mentioned have exposure in varying degrees to the duration risk factor. So, there's a common element that permeates across the entire, entire space.

Now, in terms of forming expected returns, think if one were to try and come up with expected returns for all the different types of bond indices in the universe. How, likely do you think it would be that there would be a consistency in the underlying factor views associated with that? It would essentially be zero. There's almost no chance.

But think about if you started at the risk factor level, like we do at PIMCO, if you start at the ground up by forming views on duration and credit and mortgage and so on and so forth, and then roll that up to the asset class level. What that does is it virtually ensures consistency across the entire fixed income space.

So, and this is because there's a one-to-one translation between risk factors and asset classes. It doesn't go the other way. It goes from risk factors to asset classes, not from asset classes to risk factors. So, one must start at the risk factor level to ensure that asset class views are, are consistent.

Justin: And that's helpful on the return side, but another use for risk factors is to build a lot more intuition on the risk side as well. You could look at, you know, simple asset class volatilities and simple asset class correlations. Uh, but you mentioned a few risk factors there, things like duration and, you know, equity beta or equity risk. Maybe using those as an example, can you, uh, elaborate a bit on how we use risk factors on the risk side of the equation?

Steve: Sure. Well, one of the, one of the most important considerations in portfolio construction is this relationship between the duration factor, which is effectively exposure to high quality sovereign bonds, typically US government bonds, and how the returns to that risk factor relate to things like credit and equity and so on and so forth. And over the past 20 plus years, it's primarily been the case that that correlation has been quite negative.

What that means in general, uh, is that when equity markets sell off or when, when there's an adverse movement in the credit market, exposure to high-quality duration has sort of been there as a hedge, to some degree. Not always, but largely it's been there as a hedge to offset some of that risk.

And the implication of that, then, is that balancing duration and credit or duration and equity in, say, an asset allocation portfolio, can significantly improve the portfolio's efficiency. But how do you do that, right? It's not easy. The types of things that I'm talking about are actually fairly involved and require a reasonably high degree of, of complexity and sophistication and that's why you really need a well-developed portfolio construction process in order to sort of measure these trade-offs.

Recorded 15 September 2018

Disclosure


All investments contain risk and may lose value. Investors should consult their investment professional prior to making an investment decision. 

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. 

CMR2018-1126-367270

Filters:
Filters: Reset All

Filters

X
  • Topic/Tag

    Tags

    Reset

    Close
  • Category

    Category

    Reset

    Economic and Market Commentary
    Investment Strategies
    Bond by Bond
    Viewpoints
    Careers
    Education
    PIMCO Foundation
    View from the Investment Committee
    Close
  • Order By

    Order By

    Reset

    Alphabetical
    Most Recent
    Close
() filters applied

Video Finder

Filter By:
Section
  • Economic and Market Commentary
  • Investment Strategies
  • Bond by Bond
  • Viewpoints
  • Careers
  • Understanding Investing
  • View from the Investment Committee
Experts
  • A
  • B
  • C
  • D
  • F
  • H
  • I
  • K
  • M
  • P
  • R
  • S
  • T
  • W
Clear
Tina Adatia
Fixed Income Strategist
Olivia A. Albrecht
Executive Office, ESG Business Strategy
Mike Amey
Head of Sterling Portfolio Management and ESG Strategies
Yacov Arnopolin
Portfolio Manager, Emerging Markets
Robert Arnott
Founder and Chairman, Research Affiliates
Andrew Balls
CIO Global Fixed Income
Justin Blesy
Asset Allocation Strategist
David L. Braun
Head of US Financial Institutions Portfolio Management
Erin Browne
Portfolio Manager, Multi-Asset Strategies
Libby Cantrill
Executive Office, Public Policy
Richard Clarida
Former Global Strategic Advisor, 2006-2018
Laura Deneke
Sr. Vice President, Product Strategist
Anna Dragesic
Head of Global Credit Product Strategies
Joachim Fels
Global Economic Advisor
David Fisher
Head of Traditional Product Strategies
Gene Frieda
Global Strategist
Mary Hoppe
Daniel H. Hyman
Head of Agency MBS Portfolio Management
Daniel J. Ivascyn
Group Chief Investment Officer
Mark R. Kiesel
CIO Global Credit
Nicola Mai
Portfolio Manager, Sovereign Credit Analyst
Naila Makhdumi
Account Manager, Global Wealth Management
Jason Mandinach
Credit Strategist, Mortgage Strategies
Scott A. Mather
CIO U.S. Core Strategies
Mohit Mittal
Portfolio Manager, Liability Driven Investment and Credit
Alfred T. Murata
Portfolio Manager, Mortgage Credit
Sonali Pier
Portfolio Manager, Multi-Sector Credit
Lupin Rahman
Head of EM Sovereign Credit
Emmanuel Roman
Chief Executive Officer
Loren Sageser
Credit Strategist
Steve Sapra
Client Solutions & Analytics
Jerome M. Schneider
Head of Short-Term Portfolio Management
Marc P. Seidner
CIO Non-traditional Strategies
Sapna Shah
Head of Corporate Responsibility
Anmol Sinha
Fixed Income Strategist
Cathy Stahl
Global Head of Marketing
Christian Stracke
Global Head of Credit Research
Geraldine Sundstrom
Portfolio Manager, Asset Allocation
Richard Thaler
Distinguished Service Professor of Economics and Behavioral Science at the University of Chicago's Booth School of Business
Mark Thomas
Account Manager, Global Wealth Management
Jessica K. Tom
Senior Credit Analyst
Eve Tournier
Head of European Credit Portfolio Management
Niamh Whooley
ESG Engagement Analyst
Tiffany Wilding
U.S. Economist
Andrew T. Wittkop
Portfolio Manager, Treasuries, Agencies, Rates
Mihir P. Worah
CIO Asset Allocation and Real Return
PIMCO
Chris Brightman
Order By
  • Alphabetical
  • Most Recent
Section : Date : Experts :
Reset All

Load more results Load {{cCtrl.fetchResults}} more results