In the current low-return, low-yield environment, investors believe they need to make a choice between increasing their risk or reducing their returns, but there is a more balanced approach, says Erik Knutzen, multi-asset class chief investment officer at Neuberger Berman.
“Investors are currently faced with significant challenges – return expectations are historically low while at the same time there is heightened market uncertainty spurred by geopolitical and economic regime shifts, such as Brexit and the Trump presidency.
“While investors are asking questions about how to achieve returns while minimising risk, in our view a better question is: how to harness risk in order to help achieve superior returns?
“This entails fully understanding and measuring the systemic and factor risks (such as value, momentum, quality, carry, liquidity, volatility, etc.) that drive an investment portfolio and viewing these risks from a different perspective. This is important not only to protect from drawdowns but also to reveal new, potentially rewarding investment opportunities,” Mr Knutzen said.
One of the tools being utilised by Neuberger Berman to help measure and monitor systemic risk is “spanning trees”, an approach developed by Neuberger Berman’s quantitative investment group headed by Wai Lee.
Mr Lee says that understanding the connectedness of markets has never been so important.
“If the global financial crisis taught us anything, it is that correlations can “go to one” quicker than imagined and assets that belong to one asset class can act very much like other asset classes.
“While history is filled with examples of corrections and even crashes that, in retrospect, pundits were able to dissect and link to multiple warning signs, what still remains elusive are tools that can be used effectively on a real-time or even preventative basis to navigate such tumultuous times.
“To help us achieve this, we use the concept of a ‘spanning tree’ to give a snapshot in time of how asset classes are linked and influence each other.
“As an illustration, bad weather at one airport can affect flights out of another hub even though it is a clear day there. In the same way, asset classes can influence each other in ways that, if studied in isolation, seem impossible to predict.
“Spanning trees provide a view of both risk and potential sources of volatility, using market relationships to identify the sources of systemic risk.
“This approach can help us reduce portfolio downside risk and mitigate drawdowns, as well as understand how diversified a portfolio really is,” Mr Lee said.
“Furthermore, developing an understanding of the systemic and factor risks driving portfolio outcomes can also reveal potentially rewarding investment opportunities.
“Investors can capitalise on the persistence of capital market risk to access return streams that are less dependent on traditional market betas. Factor investing enables investors to harvest returns from risk premia.
“This can be done by investing in a diversified exposure to various risk factors, such as Neuberger Berman’s “Multi-Asset Risk Premia” strategy, which seeks to deliver absolute returns from a portfolio of alternative risk premia diversified across various asset classes (equities, fixed income, currencies and commodities), or via strategies that focus on a particular risk premia, such as option strategies that enable investors to monetise equity market volatility. Neuberger Berman offers a range of systematic option strategies that are designed to take advantage of a variety of market conditions,” Mr Lee said.
Mr Knutzen added that pioneering strategies such as these are crucial to delivering superior risk-adjusted returns for investors.
“As a multi-asset allocator, having access to these investment ideas and sophisticated portfolio risk monitoring tools means our team can adapt quickly to change and capture market opportunities.”
About Neuberger Berman
Neuberger Berman, founded in 1939, is a private, independent, employee-owned investment manager. The firm manages equities, fixed income, private equity and hedge fund portfolios for institutions and advisors worldwide. With offices in 19 countries, Neuberger Berman’s team is more than 1,900 professionals and the company has been named by Pensions & Investments as a Best Place to Work in Money Management for four consecutive years. Tenured, stable and long-term in focus, the firm fosters an investment culture of fundamental research and independent thinking. It manages US$255 billion in client assets as of December 31, 2016. For more information, please visit the website at www.nb.com
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