Risk Has Trended Down... So Should I Be Nervous? Presentation to QWAFAFEW Melissa R. Brown, CFA Senior Director of Applied Research, Axioma January 8, 2013
Agenda Risk fell dramatically throughout 2012, although it remained above historical lows Forecast differences from Axioma s four model variants were driven by lower short-horizon risk in the first half and lower statistical model forecasts in the second half Factor volatility country, industry, currency, market dropped in most regions, and correlations fell, as well Trading volume in 2012 was lower than average; perhaps investors are sitting on their hands? On a separate note, despite (or perhaps because of) interest in low volatility strategies, factor performance was worse than expected in 2012
Predicted risk fell throughout most of 2012 35 Current+ 3 months ago 12 months ago 30 25 20 15 10 5 0 Russell 1000 Russell 2000 FTSE North America 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 North America Europe Asia-Pacific Global + Japan data as of 28 Dec 2012, all others as of 31 December 2012 *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.
Short-horizon forecasts ticked up in China & Japan but otherwise remained well below levels of a year ago 35 30 Current+ 3 months ago 12 months ago 25 20 15 10 5 0 Russell 1000 Russell 2000 FTSE North America 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 + Japan data as of 28 Dec 2012, all others as of 31 December 2012 *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.
Forecasts in Europe ended 2012 in line with US 26% 24% 22% 2 18% 16% 14% 12% 1 Dec Jan Feb Mar Russell 1000 Apr May Jun Jul Aug Sep Oct Nov Dec 26% 24% 22% 2 18% 16% 14% 12% 1 Dec Jan Feb Mar Apr May Jun Jul Russell 2000 Aug Sep Oct Nov Dec 28% 26% 24% 22% 2 18% 16% 14% 12% 1 FTSE Developed Europe Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Medium Horizon Fundamental Medium Horizon Statistical Short Horizon Fundamental Short Horizon Statistical Source: FTSE, Russell Investments, Axioma Inc.
Japan and China were somewhat different 21% 2 19% FTSE Japan 3 25% FTSE Asia Pacific ex-japan 18% 17% 2 16% 15% 14% 15% 13% 12% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 28% CSI 300 26% 24% 22% 2 18% 16% 14% 12% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Medium Horizon Fundamental Short Horizon Fundamental Medium Horizon Statistical Short Horizon Statistical Source: FTSE, Russell Investments, China Securities Index Company, Ltd, Axioma Inc.
Global risk was close to a 5-year low And well below peaks of the Global and European financial crises 6 5 FTSE Global Developed Index 4 3 2 1 2008 2009 2010 2011 2012 Medium Horizon Fundamental Medium Horizon Statistical Short Horizon Fundamental Short Horizon Statistical Source: FTSE, Axioma Inc.
But it is not quite at a 25-year low (US) Source: FTSE, Russell Investments, Standard & Poor's, Axioma Inc.
Global risk was lower in the mid-2000s Source: Russell Investments, Axioma Inc.
Short vs. medium forecast drove first half disagreement Total Risk Spread 14% 12% 1 8% 6% 4% 2% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 8% 7% 6% 5% 4% 3% 2% 1% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Short Horizon Medium Horizon 4% 2% -2% -4% -6% -8% -1 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 4% 2% -2% -4% -6% -8% -1 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Solid line: Fundamental Models Dotted line: Statistical Models
Statistical & fundamental models diverged after July for US and Global Statistical - Fundamental 4% 4% 2% 2% -2% -2% -4% -4% -6% -6% -8% -8% -1 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec -1 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Solid line: Medium Horizon Dotted line: Short Horizon Source: FTSE, Russell Investments, Axioma Inc.
Volatility and Correlation contributed to risk s drop Results in Japan and China were muted Factor Decomposition 2% -2% -4% -6% -8% -1-12% -14% -16% Portfolio composition Stock characteristics Stock specific volatility Factor volatility Factor correlations 2% Full Matrix Decomposition -2% -4% -6% -8% -1 Portfolio composition Stock volatility Stock correlations Source: FTSE, Russell Investments, China Securities Index Company, Ltd Axioma Inc.
Single-country realized correlations have dropped, Except in China 0.8 Russell 1000 Russell 2000 FTSE Japan CSI 300 Sep 2011 0.7 0.6 0.5 0.4 0.3 0.2 0.1 Oct 2012 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: FTSE, Russell Investments, Axioma Inc.
Multi-country benchmark correlations dropped too 0.7 FTSE Developed Europe FTSE Asia ex-japan FTSE Developed FTSE Emerging 0.6 0.5 0.4 0.3 0.2 0.1 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: FTSE, Russell Investments, Axioma Inc.
And cross-sectional dispersion remains low 3 Russell 1000 Russell 2000 FTSE Japan CSI 300 3 FTSE Developed Europe FTSE Developed FTSE Asia ex-japan FTSE Emerging 25% 25% 2 2 15% 15% 1 1 5% 5% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: FTSE, Russell Investments, China Securities Index Company, Ltd Axioma Inc.
VIX and VSTOXX were also well below average 100 90 80 VIX VSTOXX 70 60 50 40 30 20 10 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Yahoo! Finance, Axioma Inc.
Should we be worried risk will spike soon? On one hand, there is still a lot of uncertainty Election over and fiscal cliff averted, but looming debt ceiling, many other issues But, all of these issues could already be baked into stock prices and hence are therefore no longer driving volatility The extreme uncertainty may have simply paralyzed investors and therefore volatility has declined - trading volume was extremely low for most of 2012 But There is always something to worry about 2013 concerns are not unique! Statistical model results suggest there isn t something bubbling under the surface Historically, risk has remained low for long stretches of time
Monthly volume has been lower than average Average daily traded value FTSE Global Developed Index % of Total Market Cap Monthly average volume % of Total Market Cap 1.4% 0.7% 1.2% 0.6% 1. 0.5% 0.8% 0.4% 0.6% 0.3% 0.4% 0.2% 0.2% 0.1% 0. 2000 2002 2004 2006 2008 2010 2012 0. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Monthly Average 2000-2011 2012 Source: FTSE, Axioma Inc.
Volume was lower in most developed countries Last 3 months vs. long-term average 4 Current liquidity relative to history 2-2 -4-6 -8 Source: FTSE, Axioma Inc.
All sectors and size quartiles had lower volume Last 3 months vs. long-term average -5% -1-15% -2-25% Current liquidity relative to history -2% -4% -6% -8% -1-12% -14% -16% -18% -2 1 (Largest) 2 3 4 (Smallest) Source: FTSE, Axioma Inc.
Comment on low volatility strategies 8 6 US Europe Asia Pac ex JP Japan China Global Emerging 4 6 2 0-2 -4-6 -8-10 -12 4 2 0-2 -4-6 -8-10 -12 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Source: Axioma Inc.
Volatility s return: US & Europe lower than average Axioma Volatility factor average monthly return 0.6 2012 Since 1999 0.4 0.2 0.0-0.2-0.4-0.6-0.8-1.0-1.2-1.4 US Europe Japan China Asia ex JP Global Emerging Source: Axioma Inc.
Summary Risk declined substantially in 2012, especially at the short horizon Decrease was driven by lower volatility and correlation Short horizon was falling faster than medium in 3Q, but no longer Negative statistical-fundamental spread suggests markets aren t picking up a brewing issue Low realized correlation suggests stocks are less tied to macro themes Dispersion is related to correlation, but also affected by volatility It is low relative to historical averages It is more important than correlation to fundamental managers ability to add value Global trading volume was low for most of 2012 perhaps investors were waiting out the storm Low volatility strategies may have struggled a bit at the end of 2012 Risk may finally be settling down after the financial crisis!