How can Investment Firms achieve Strategy Diversification via Risk Assessment?

FINVENT Consulting Services Group | 22 August 2023

Portfolio Managers continuously pursue portfolio out-performance that aims to minimize unwilling excessive portfolio risks. Portfolio management software solutions can analyze the daily challenges and risks that managers face and provide automated ways of resolving or mitigating them.

Diversifying via Risk Contribution Analytics

The CIOs of asset management firms often supervise the management of large numbers of multi-asset portfolios with exposure to different countries, currencies and instruments. The ongoing measurement of market risk across assets and geographies can therefore get quite cumbersome and requires the automation of the risk measurement process, to ensure that risk policy guidelines set at inception are respected.

Let us assume that a balanced portfolio is comprised of Equities, Fixed Income, Commodities and Derivatives holdings, spread across Europe, USA and the UK. If the manager wishes to quantify the units of risk taken to achieve a realized performance over a certain time period, a risk assessment toolkit can provide the Average Weight, Return, Return Contribution and Average Component Value at Risk (VaR) at the asset class and geography level, for the selected period. This way, the manager can view the risk-adjusted portfolio performance in the highest possible segment granularity.

A detailed risk decomposition can be reported for any list of categorisations that are originally maintained in the reference portfolio management system, such as asset class, sector, risk country, reference currency, issuer credit rating, or constituent security holdings. This way, no asymmetries between each segment’s performance contribution and its associated risk can escape attention, in order to facilitate a portfolio diversifying framework.

Supporting Hybrid Business Models

A number of asset management firms deploy hybrid business models, with its managers not only managing proprietary strategies but also composing customised portfolios comprised of 3rd party fund managers. As most strategies tend have multi-asset-class mandates, one needs to monitor how strategies interact with each other, to ensure that changing market conditions do not gradually lead to highly positive correlated risks.

A risk assessment system can provide a single report with an overview of how asset allocation decisions made by all managers affect the total portfolio exposure to market risk. This way one can juxtapose a full list of proprietary strategies or managers next to their associated Market Values and VaR figures, segmented by the asset classes held.

Such analysis helps monitor the risk-adjusted portfolio performance but also factor in all cross-correlations between the individual portfolios, producing total performance and risk figures for the consolidated firm-wide exposure. This way the CIO/CEO can directly look at any return benefits that can be achieved via the existence of a diverse basket of investment strategies.

FINVENT Software Solutions is a producer and distributor of financial software applications and custom engineering services for the investment management sector. The firm serves financial institutions in European and African countries, including asset managers, family offices, investment banks, pension funds and hedge funds. Its award-winning KlarityRisk platform specializes in multi-dimensional investment risk analytics, stress-testing simulation scenarios, risk limits management, and fixed income performance attribution reporting.

Disclaimer: Nothing contained in the aforementioned references constitutes an investment solicitation or a recommendation of any type.