A Portfolio Manager Questions a Risk Engine II: Strategy Diversification for Managers and Firms

Yannis Sardis, 5 April 2021

The first note of our Series exhibited the concepts of Value at Risk and its derivatives, and addressed questions emanating from the need of a Portfolio Manager (PM) to ensure that the pursue for out-performance is not unwillingly paired with excessive portfolio risks.

We continue our Q&A session with KlarityRisk (KR), our smart risk software engine, and focus on the daily challenges and risks that investment managers face and tested ways of resolving or mitigating them.

PM: As the CIO of a Wealth Management firm, I supervise the management of a basket of multi-asset portfolios with exposure to different countries and currencies. Consequently, the ongoing measurement of market risk across assets and geographies is cumbersome.

How can you facilitate an automated process of risk measurement, so that I can ensure that, at all times, we remain within the risk policy guidelines set at inception?

KR: Let us assume that a balanced portfolio of yours is comprised of Equities, Fixed Income, Commodities and Derivatives holdings, which are spread across Europe, USA and the UK. You wish to quantify the units of risk that you took in order to achieve your realised performance over a certain time period. In a single screen, I can show you the Average Weight, the Return, the Return Contribution and the Average Component VaR, per asset class and geography, for the selected period. This way, you can view your risk-adjusted performance in the highest possible segment granularity.

PM: Can you perform such a risk contribution analysis only at an asset class or a geography level?

KR: Certainly not. I can provide you with a risk decomposition for any list of categorizations that you maintain in your portfolio management system, where you hold all your portfolio positioning. Categorisations can include the asset class, sector, risk country, reference currency and issuer credit rating, down to the underlying security holdings. This way, no asymmetries between each segment’s performance contribution and its associated risk can escape your attention.

PM: My firm deploys a hybrid business model, i.e. our PMs manage our proprietary strategies (mainly for institutional investors), and we also compose customised portfolios comprised of 3rd party fund managers (mainly for high net worth clients).

As certain strategies have a multi-asset-class mandate, how can I monitor how they ‘interact’ with each other, to ensure that changing market conditions do not gradually lead us to be holding highly positive correlated risks?

KR: In a single report you can have an overview of how decisions made by all the actors in your firm and their resulting multi-asset class allocations for multiple investment portfolios affect your portfolios’ total exposure to market risk. This way you can juxtapose a full list of your proprietary strategies, or PMs or Relationship Managers, next to their associated Market Values and Value at Risk figures, segmented by the asset classes held.

PM: Does your analysis treat my investment strategies as stand-alone portfolios?

KR: On the contrary, our analysis not only helps you monitor the risk-adjusted performance of your portfolios but it also factors in all cross-correlations between the individual portfolios, and produces total performance and risk figures for your consolidated firm-wide exposure. This way, at all times, you can have a glance at any return benefits that are achieved (or not) via the use of a diverse set of investment strategies.

PM: Our next Q&A session will address the notions of historical, customised and hybrid portfolio stress-testing.

FINVENT Software Solutions is a provider of financial software applications and custom engineering services. The award-winning KlarityRisk platform specializes in investment risk analytics and fixed income performance attribution reporting and it is offered to Private Wealth institutions, Asset and Hedge Fund Managers and Family Offices.

Would you like to know more about our Portfolio and Risk Management solutions? Please contact us at info@finvent.com and we will get in touch.