The Journal of Portfolio Management
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.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees.
This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.