Exploring Macroeconomic Sensitivities

Topics - Macroeconomics Alternative Investing Equities Factor/Style Investing Fixed Income

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Exploring Macroeconomic Sensitivities

Forecasting economic and market conditions is no easy task. More-confident investors pick a particular macroeconomic (macro) view and construct a portfolio that aims to excel in the chosen environment. Investors more humble about their forecasting ability may prefer to construct diversified portfolios that are robust across a variety of macro environments. But in order to construct their portfolios, both types of investors need to understand how various investments have fared in different macro conditions.

“Risk-based investing” can mean different things to different investors, but the common feature is the emphasis on improved risk diversification. While many investors identify risks primarily as asset-class exposures, others may look at underlying macroeconomic exposures (such as inflation sensitivity). The difficulty with the latter approach is that macroeconomic factors are not directly investable.

In this paper, we study the sensitivity of traditional asset classes and dynamic strategies to different macroeconomic environments (growth, inflation, real yields, volatility and illiquidity). We identify environments that are particularly challenging for investors, and find evidence that dynamic systematic strategies, known as style premia, have meaningfully less macro exposure than do asset classes. We also show how diversification reduces portfolios’ macro risk exposures.

Since investors cannot be certain of the future economic environment, they should try to prepare their portfolios for any eventuality. Just as a portfolio’s performance can be made more robust through better risk diversification across investable return sources, we believe it can also be improved by more balanced macro exposures.

Published in

The Journal of Portfolio Management

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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither AQR nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.

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