The Current Risk Landscape Axioma Insight Findings Melissa R. Brown, CFA
About Axioma Axioma provides portfolio construction, risk modeling and performance attribution tools to asset managers and asset owners We use risk data to assess and explain the environment in which managers are investing Today we will discuss some of the findings and insights about the market landscape from our risk models First, a quick review of the nature of the risk models 2
Risk 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 3
Axioma Risk Models Axioma s standard product includes 4 risk models per region By horizon Short horizon: 1 to 2 month forecast Medium horizon: 3 to 6 month forecast By factor structure Fundamental: uses predefined set of factors, such as country, industry, currency, style Statistical: lets the data speak Models are provided for 14 countries/regions/global 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 4
2014 Review Equity risk fell from February through mid-september 2014 in most regions, but then staged a sudden and substantial turnaround Risk was up across the board The biggest increases were in China and Japan Aggregate country, currency, style, industry and market risk all rose Almost all countries saw big volatility increases The differences between countries risk grew larger Canada saw the biggest increase of any developed country Most individual currencies saw risk increase as well Correlations remained low, but increased from recent bottoms Higher asset correlations had a large impact on risk Emerging market risk remained low relative to developed market US small cap risk relative to large-cap peaked in July, then tumbled Energy risk soared, even as weight fell
2015 Themes The increase in risk has abated, but has not reversed appreciably Currency risk continued to increase Market and country risk have flattened Risk up sharply in most developed currencies, mixed for emerging CAD increase relative to USD second only to CHF Small-cap relative to large-cap risk still low Emerging relative to developed still low Energy risk remains elevated, although it has leveled off Asset dispersion has increased good for stock pickers! Canada s factor performance has been different from other markets Understanding the changing components of risk is quite important for asset managers! 6
Russell 1000 Russell 2000 TSX Composite FTSE 350 FTSE Eurobloc FTSE Europe Non-Eurobloc* Euro Crisis*** FTSE Asia Pacific FTSE Asia Pacific ex-japan SP-ASX 200 China CSI 300 FTSE Japan FTSE Developed FTSE Emerging FTSE-All World Risk, Up Sharply in Q4, Down Slightly YTD 30 25 Short-Horizon Predicted Volatility 31-Dec-13 20 15 10 5 0 North America Europe Asia-Pacific Global *FTSE Europe minus FTSE Eurobloc **FTSE Developed Europe minus FTSE Eurobloc ***Portugal, Italy, Ireland, Greece and Spain from FTSE Eurobloc Source: FTSE, Russell Investments, Standard & Poor's, China Securities Index Company, Ltd, Axioma Inc. 7
Russell 1000 Russell 2000 TSX Composite FTSE 350 FTSE Eurobloc FTSE Europe Non-Eurobloc* Euro Crisis*** FTSE Asia Pacific FTSE Asia Pacific ex-japan SP-ASX 200 China CSI 300 FTSE Japan FTSE Developed FTSE Emerging FTSE-All World Risk, Up Sharply in Q4, Down Slightly YTD 30 Short-Horizon Predicted Volatility 25 30-Sep-14 31-Dec-13 20 15 10 5 0 North America Europe Asia-Pacific Global *FTSE Europe minus FTSE Eurobloc **FTSE Developed Europe minus FTSE Eurobloc ***Portugal, Italy, Ireland, Greece and Spain from FTSE Eurobloc Source: FTSE, Russell Investments, Standard & Poor's, China Securities Index Company, Ltd, Axioma Inc. 8
Russell 1000 Russell 2000 TSX Composite FTSE 350 FTSE Eurobloc FTSE Europe Non-Eurobloc* Euro Crisis*** FTSE Asia Pacific FTSE Asia Pacific ex-japan SP-ASX 200 China CSI 300 FTSE Japan FTSE Developed FTSE Emerging FTSE-All World Risk, Up Sharply in Q4, Down Slightly YTD 30 25 Short-Horizon Predicted Volatility 31-Dec-14 30-Sep-14 31-Dec-13 20 15 10 5 0 North America Europe Asia-Pacific Global *FTSE Europe minus FTSE Eurobloc **FTSE Developed Europe minus FTSE Eurobloc ***Portugal, Italy, Ireland, Greece and Spain from FTSE Eurobloc Source: FTSE, Russell Investments, Standard & Poor's, China Securities Index Company, Ltd, Axioma Inc. 9
Russell 1000 Russell 2000 TSX Composite FTSE 350 FTSE Eurobloc FTSE Europe Non-Eurobloc* Euro Crisis*** FTSE Asia Pacific FTSE Asia Pacific ex-japan SP-ASX 200 China CSI 300 FTSE Japan FTSE Developed FTSE Emerging FTSE-All World Risk, Up Sharply in Q4, Down Slightly YTD 30 25 Short-Horizon Predicted Volatility 27-Feb-15 31-Dec-14 30-Sep-14 31-Dec-13 20 15 10 5 0 North America Europe Asia-Pacific Global *FTSE Europe minus FTSE Eurobloc **FTSE Developed Europe minus FTSE Eurobloc ***Portugal, Italy, Ireland, Greece and Spain from FTSE Eurobloc Source: FTSE, Russell Investments, Standard & Poor's, China Securities Index Company, Ltd, Axioma Inc. 10
The Increase Has Leveled Off But In General Hasn t Reversed Short-Horizon Fundamental Risk Forecast 21% 19% 17% 15% 13% 33% 28% 23% 18% 11% 9% 7% Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Russell 1000 Russell 2000 FTSE Developed Europe TSX Composite 17% 16% 15% 14% 13% 12% 11% 10% 9% 13% 8% Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan 8% Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan FTSE Japan CSI 300 FTSE APxJP ASX 200 FTSE Global Developed FTSE Emerging Source: FTSE, Russell Investments, Standard & Poor s, China Securities Index Co., Axioma Inc. 11
Small Cap Risk Has Stayed Unusually Low Relative to Large Cap 1.8 Russell 2000 vs. Russell 1000 Risk 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1 0.9 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Russell Investments, Axioma Inc. 12
Developed Markets: SH Currency Risk Doubled From September to December 13.0% Short Horizon 5.5% 12.0% Medium Horizon 4.5% 12.0% Market-SH (Left) Country-SH (Right) Currency-SH (Right) 5.0% 4.5% 11.0% 4.0% 11.0% 4.0% 10.0% 3.5% 10.0% 3.5% 9.0% 3.0% 9.0% 3.0% 2.5% 8.0% 2.5% 8.0% Market-MH (Left) Country-MH (Right) Currency-MH (Right) 2.0% 2.0% 7.0% 1.5% 7.0% 1.5% 6.0% Jan Mar May Jul Sep Nov Jan 1.0% 6.0% Jan Mar May Jul Sep Nov Jan 1.0% Source: FTSE, Axioma, Inc. 13
Currency Risk Up Across-the-Board So Far This Year CAD Increase Quite High Developed Market Currency Volatility (vs. USD) 12% Risk Level 40% Change in Risk 10% 30% 8% 20% 10% 6% 0% 4% -10% 2% -20% Q1 2015 To Date 2014 0% CHF CAD NOK GBP SEK AUD NZD DKK EUR SGD JPY -30% CHF CAD NOK GBP SEK AUD NZD DKK EUR SGD JPY Source: Axioma, Inc. As of March 3, 2015 14
Canada s Country Risk Remains Relatively Low 20% 18% 16% Extra-Market Country Risk Level: Developed 14% 12% 10% 8% 6% 4% 2% 0% Source: Axioma, Inc. As of March 3, 2015 15
Many Countries Have Seen Risk Soar Canada Has Had The Biggest Increase of All 100% 80% Change in Extra-Market Country Volatility: Developed Q1 2015 To Date 2014 60% 40% 20% 0% -20% -40% 290% 190% 90% -10% Switzerland Source: Axioma, Inc. Through March 3, 2015 16
Bonds Haven t Reacted to Equity Uncertainty Potential central bank action is probably a bigger force 6% Sovereign Yields 5% 4% 3% 2% 1% 0% -1% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar US Germany UK Netherlands France Ireland Italy Spain Portugal Canada Source: Markit, Axioma, Inc. 17
CDS Spreads Point to Higher Investor Confidence 4.0 3.5 Germany France Netherlands Spain Ireland Italy Portugal UK 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Source: Markit, Axioma, Inc. 18
EM Market, Country and Currency Risk Have Risen As Well but less than DM FTSE Emerging Markets Index 13.0% Short Horizon 5.5% 12.0% Medium Horizon 4.5% 12.0% 11.0% Market-SH (Left) Country-SH (Right) Currency-SH (Right) 5.0% 4.5% 4.0% 11.0% 10.0% 4.0% 3.5% 10.0% 3.5% 9.0% 3.0% 9.0% 8.0% 3.0% 2.5% 8.0% Market-MH (Left) Country-MH (Right) Currency-MH (Right) 2.5% 2.0% 7.0% 2.0% 1.5% 7.0% 1.5% 6.0% Jan Mar May Jul Sep Nov Jan 1.0% 6.0% Jan Mar May Jul Sep Nov Jan Source: FTSE, Axioma, Inc. 19 1.0%
Big Difference in Currency Volatility Changes Last Year 40% 35% Change in Emerging Currency Volatility (vs. USD) 60% 40% Q1 2015 2014 30% 20% 25% 20% 0% 15% 10% 5% 0% RUB BRL ZAR TRY MXN IDR INR THB TWD CNY Source: Axioma, Inc. -20% -40% -60% 770% 570% 370% 170% -30% OMR UAH RUB ZAR TRY CNY MXN INR BRL IDR THB As of March 3, 2015 20
Russia and Oman are the Most Volatile 35% Extra-Market Country Risk: Emerging 30% 25% 20% 15% 10% 5% 0% Source: Axioma, Inc. As of March 3, 2015 21
Many Reversals in Country Volatility from Last Year 140% Change in Extra-Market Country Volatility: Emerging 120% 100% 80% 2014 Q1 2015 280% 180% 80% 60% 40% -20% Oman Ukraine 20% 0% -20% -40% -60% Source: Axioma, Inc. Through March 3, 2015 22
Most EM Sovereigns Have Been Relatively Flat but Russia stands out 18% 16% Sovereign Yields 14% 12% 10% 8% 6% 4% 2% 0% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar China Malaysia Mexico Brazil Indonesia Russia South Africa India Turkey Source: Markit, Axioma, Inc.
Russia Stands Out on CDS as Well 7.0 Brazil Malaysia China Indonesia South Africa Mexico Russia 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Source: Markit, Axioma, Inc. 24
EM Risk Still Low Relative to DM 1.9 1.8 1.7 Emerging vs. Developed Medium-Horizon Risk 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: FTSE, Axioma Inc. 25
EM Risk/Reward 40% September 30, 2014 40% February 27, 2015 30% 30% 20% 20% 10% 10% 0% 0% -10% Developed Emerging -10% -20% 0% 10% 20% 30% 40% Developed Emerging -20% 0% 10% 20% 30% 40% 26
Currency Correlations Have Trended Down Since Late 2012 0.5 Worldwide Model Median Factor Correlations 0.4 0.3 0.2 0.1 0.0-0.1-0.2 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Axioma, Inc. Style Country Industry Currency 27
VIX and VSTOXX: VIX VIX Average VSTOXX VSTOXX Average 100 90 80 70 60 50 35 30 25 20 15 10 5 0 Jan Feb Mar 40 30 20 10 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 Average since 1999 Source: Yahoo! Finance, STOXX, Axioma Inc. 28
Although Still Low, Asset Correlations Increased in Q4 Median 60-day realized asset-asset correlation Russell 1000 Russell 2000 TSX Composite 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 2000 2002 2004 2006 2008 2010 2012 2014 FTSE Japan CSI 300 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 2000 2002 2004 2006 2008 2010 2012 2014 0.7 FTSE Developed Europe FTSE Asia ex-japan 0.40 FTSE Developed FTSE Emerging 0.6 0.35 0.5 0.30 0.4 0.25 0.3 0.20 0.2 0.15 0.1 0.10 0 0.05 2000 2002 2004 2006 2008 2010 2012 2014 0.00 2000 2002 2004 2006 2008 2010 2012 2014 Source: FTSE, Russell Investments, China Securities Index Company Ltd., Axioma Inc. 29
Asset Dispersion Is Has Risen Style Dispersion Generally Did Not 16% 14% Average Monthly Asset Dispersion Jan-Feb 2015 Q4 2014 2014 Long-Term 12% 10% 8% 6% 4% 2% 3% 3% 0% Russell 1000 Russell 2000 TSX Composite FTSE Developed Europe Average Style Factor Dispersion FTSE Asia ex- Japan Jan-Feb 2015 Q4 2014 2014 Long-Term FTSE Japan CSI 300 ASX 200 FTSE Developed FTSE Emerging 2% 2% 1% 1% 0% US Europe Asia ex-japan Japan China Australia Worldwide Emerging Source: FTSE, Russell Investments, Standard & Poor's, China Securities Index Company, Ltd, Axioma Inc. 30
Factor Performance: Momentum Stumbled Badly in February Value Has Fallen Far Short in Canada, Especially in Q4 10 Momentum 6 Value 8 4 6 2 4 0 2-2 0-4 -2-6 -4 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb -8 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb US EU AP JP AU CA US EU AP JP AU CA Source: Axioma Inc.
Factor Performance: Growth and Leverage Stood out in Canada 3.0 Leverage 6.0 Growth 2.5 5.0 2.0 4.0 1.5 1.0 3.0 0.5 2.0 0.0 1.0-0.5 0.0-1.0-1.0-1.5-2.0-2.0 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb US EU AP JP AU CA -3.0 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb US EU AP JP AU CA Source: Axioma Inc.
Factor Performance: Low Volatility Has Worked Well Globally; Liquidity Had A Wild Ride in Canada 2 Volatility 3 Liquidity 0 2-2 1-4 0-6 -1-8 -2-10 -3-12 -4-14 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb US EU AP JP AU CA -5 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb US EU AP JP AU CA Source: Axioma Inc.
ENERGY 34
Energy s Risk Has Risen Substantially Since May 3.0 160 2.5 2.0 Risk: Energy/Russell 1000 (Left) WTI Oil Price (Right) 140 120 100 1.5 80 1.0 0.5 60 40 20 0.0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Source: Federal Reserve Bank of St. Louis, Axioma, Inc. 0 35
Energy s % of Risk Continued to Exceed Its Benchmark Weight Energy Weight Vs. Percent of Risk 11.0% Russell 1000 40.0% TSX Composite: Energy Weight Vs. Percent of Risk 10.5% 10.0% 35.0% 9.5% 9.0% 30.0% 8.5% 25.0% 8.0% 7.5% Weight Percent of Risk 7.0% Jan Mar May Jul Sep Nov Jan 20.0% Weight Percent of Risk 15.0% Jan Mar May Jul Sep Nov Jan Mar Source: Russell Investments, Axioma, Inc. 36
Risk for Energy-Related Industries In Most Regions Has Leveled Off Oil-Related Industry Extra-Market Risk 35% 35% 30% 25% 20% 15% 10% 5% 30% 25% 20% 15% 10% 5% 0% Jan Mar May Jul Sep Nov Jan Mar US:Energy Equipment & Services US:Oil, Gas & Consumable Fuels CA:Energy EU:Energy 0% Jan Mar May Jul Sep Nov Jan Mar Source: Axioma, Inc. AP:Energy JP:Energy AU:Energy CN:Energy ex Coal 37
Oil and Energy Have Seen The Biggest Changes In Correlations Change in US3 MH Factor Correlation, May 31, 2014 March 3, 2015
Daily Risk Monitors We provide daily risk monitors for US Canada 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 39
Summary: Major Findings Risk rose last year, in some cases doubling from low levels reached last fall. Markets have been calmer this year, and risk changes have been much smaller Increases in volatility were driven by a number of factors Will economies slow in in Europe, China, Japan? Will euro be broken up? Will oil continue to tumble? Will we see deflation, especially in Europe? Etc. For a global benchmark market, country and currency risk all rose last year, and remain elevated The stronger US dollar meant volatility of most currencies relative to USD increased sharply in Q4, and into this year Despite the widespread increases currency correlations actually fell Individual country volatility changes were mixed but some rose substantially Momentum had some very difficult days in February, especially in the US, Canada and Europe. Returns have settled down since then. Canada has seen streaks of unusually good or bad performance (sometimes both) in Value, Leverage, Growth, and Liquidity 40
Summary: Major Findings In the US, after a peak in relative volatility in July, small-cap stocks have fallen to low volatility levels relative to large-cap. Emerging market risk stayed low relative to developed. Canada s risk has risen quite a bit relative to that in other markets Energy stock risk experienced a sudden and steep increase, and energy correlations with other factors have changed substantially. Bond yields and CDS spreads generally remained stable or fell 41
Summary: Implications for Portfolio Managers 2014 was a tough year for active management. A low-risk environment may have truncated opportunities. Flip-flopping factor performance meant a difficult environment for factorbased managers as well. While volatility has gone up since the fall, driving risk up, the impact of asset correlations has also been surprisingly high in some regions. Correlations (especially currency and style factor) have changed substantially in many markets. Factor volatility rose in many cases (but remains low relative to longer history). Changes in the components of risk (correlations, volatility, and specific factors like energy, emerging vs. developed, and currency markets) suggest it may be a good time for portfolio managers to reevaluate their portfolios sources of risk. Increasing differentiation in risk and potential reward may be good for active managers who are able to effectively sort the winners from the losers. Scaling bets appropriately, as always, will be key. 42
For more information on any of these slides or any of Axioma s other offerings, please contact your account representative or sales@axioma.com I can also be reached at mbrown@axioma.com or 212-991-4507 43