Measuring Factor Exposures: Uses and Abuses
Ronen Israel and Adrienne Ross (AQR Capital Management)
September 19, 2016
A growing number of investors have come to view their portfolios (especially equity portfolios) as a collection of exposures to risk factors. The most prevalent and widely harvested of these risk factors is the market (equity risk premium); but there are also others, such as value and momentum (style premia).
Measuring exposures to these factors can be a challenge. Investors need to understand how factors are constructed and implemented in their portfolios. They also need to know how statistical analysis may be best applied. Without the proper model, rewards for factor exposures may be misconstrued as alpha, and investors may be misinformed about the risks their portfolios truly face.
This paper should serve as a practical guide for investors looking to measure portfolio factor exposures. We discuss some of the pitfalls associated with regression analysis, and how factor design can matter a lot more than expected. Ultimately, investors with a clear understanding of the risk sources in an existing portfolio, as well as the risk exposures of other portfolios under consideration, may have an edge in building better diversified portfolios.
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Effective Fed Funds Rate (30-Day Average) Rises To 8-Year High
The Federal Reserve yesterday left interest rates unchanged, but the monetary policy statement issued by the central bank on Wednesday hinted at the possibility of a rate hike in December. A day earlier (Nov. 1), the 30-day average of the effective Fed funds rate inched above 0.40% for the first time in eight years.
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Risk Premia Forecasts: Major Asset Classes | 2 November 2016
The Global Market Index’s expected risk premium held steady in October, sticking to the highest level since May 2015. GMI — an unmanaged market-value weighted mix of the major asset classes — is expected to earn an annualized 3.9% risk premium over the long term, unchanged from last month’s estimate.
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Major Asset Classes | October 2016 | Performance Review
Global markets spilled a lot of red ink in October across the major asset classes. Last month’s only gainer: emerging market stocks, which edged up 0.2%, based on the MSCI EM Index. Otherwise, losses dominated the kickoff month for the fourth quarter.
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Widespread Selling Pulled Most Asset Classes Down Last Week
The major asset classes lost ground last week, with one exception: foreign high-yield bonds. Otherwise, red ink dominated the broad categories of global markets for the five trading days through Oct. 28, based on a set of proxy ETFs.
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Book Bits |29 October 2016
● No More Work: Why Full Employment Is a Bad Idea
By James Livingston
Summary via publisher (University of North Carolina Press)
For centuries we’ve believed that work was where you learned discipline, initiative, honesty, self-reliance–in a word, character. A job was also, and not incidentally, the source of your income: if you didn’t work, you didn’t eat, or else you were stealing from someone. If only you worked hard, you could earn your way and maybe even make something of yourself. In recent decades, through everyday experience, these beliefs have proven spectacularly false. In this book, James Livingston explains how and why Americans still cling to work as a solution rather than a problem–why it is that both liberals and conservatives announce that “full employment” is their goal when job creation is no longer a feasible solution for any problem, moral or economic.
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Is The Labor Market Conditions Index Forecasting A Recession?
Inferring recession probabilities from one indicator is a dodgy way to monitor business-cycle risk, but it’s forever popular. Last week I criticized an effort to estimate recession risk by using the ISM Manufacturing Index in isolation; today we focus on a similar attempt to use the Labor Market Conditions Index (LMCI) as the basis for deciding if the US economy has slipped over to the dark side.
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Should We Believe The Bond Market’s Rising Inflation Forecast?
The Federal Reserve has been trying to raise inflation for eight years with, so far, muted results. But some analysts think we’re at an inflection point and pricing pressures will continue to strengthen. The Treasury market’s implied inflation estimate seems to agree, supported by moderately firmer numbers in the official inflation statistics.
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Market Data Hints At Higher Rate-Hike Odds
The Federal Reserve isn’t expected to raise interest rates at next week’s policy meeting, but the Nov. 1-2 gathering will be closely watched for signs that the central bank is preparing to make a move when it reconvenes in December.
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Economists Expect A Moderate Rebound For US Q3 GDP Growth
The US economy is on track to expand at the fastest rate in more than a year in the third quarter, according to projections for this Friday’s “advance” GDP report from the Bureau of Economic Analysis. A range of estimates anticipate that quarterly output will top 2% (seasonally adjusted annual rate). If the prediction holds up, output is set to break free of the sluggish pace of roughly 1.0% that’s prevailed in each of the previous three quarters.
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