Risk Management

Step1:

Defining Risk Budgets

We define, quantify and invest our portfolios,  using a  budgeting framework expressing exposure in terms of "cash usage" (leverage), "independent tracking-error" (standard deviation), and "value-at-risk" (maximum expected shortfall over a given time horizon).

     Sample Portfolio Risk Snapshot
  • "Cash usage" is the simplest way to express exposure, measuring the extent by which a pool of cash is being put to work for any purpose of investment within a given portfolio. 

  • "Independent Tracking error" measures the volatility of returns considered individually at the position level and then aggregated at the portfolio level. It is a simple measure of standard deviation (volatility).

  • "Value-at-risk" determines the maximum loss that a portfolio can statistically be expected to suffer, with a given set of positions, in the worst case, over a given time horizon (typically one year) and with a given confidence level (95% or 99%). This confidence level will establish that only 5% or 1% of the time can you be expected to lose more (without specifying how much) than this "var" number. The advantage of a var based estimation of exposure is that it integrates diversification benefits in the estimation of the aggregate exposure of a portfolio (as opposed to "cash usage" and "independent tracking error").

Step 2:

Allocating  Risks

Using an Investor Profile Based Value-at-Risk Global Limit

VAR limits are defined in function of the investors' risk profile and investment preferences. They are expressed in % of the total return.

Using Independent Tracking Error to Calibrate Positions (Risk Parity)

 

We rely on the concept of "tracking error" to calibrate positions around a strategic asset allocation for the global strategic portfolios or around cash for the tactical portfolios. This enables us to allocate risks before allocating capital which is the hallmark of "Risk Parity" investing, best suited to pursue "All Weather" investment strategies which, in our case, are expressed in their purest form with a Global Tactical (GT) model portfolio mandate.

 

We use the var budget to reduce or increase exposure on a tactical basis (be it in equity, bond, precious metals, or commodity markets) with the purpose of generating added value and shield the portfolio from excessive volatility or adverse trend developments. This leeway is expressed in terms of "independent tracking error" (or standalone volatility).

 

Each"market view" is weighted in function of its "independent tracking error".

For example, if we wish to allocate a 2%  tracking error on the anticipation that the South African rand will appreciate vs. USD, the nominal position will be different than if we wish to allocate a 2% tracking error on the expectation that 5 years US treasury yields will go up or down. The more volatile or risky the underlying asset for any given market view, the smaller the position for any level of confidence in our associated market view.

The level of confidence held in our views is expressed as a percentage usage (ranging from 0 % to 100%) of a global tracking error budget (typically set at 10%).

The portfolios' tracking error consumption might vary over time, typically as a function of the accumulated added value of the portfolio over a  given time period. 

Our focus on risk management in an effort to smooth out the expected return volatility and avoid whenever possible large drawdown. This requires a combination of active risk management and discipline. 

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