Optimization, Valuation, Diversification, and Risk in Constructing Global Portfolios
Moderated by Harin de Silva, CFA, Analytic Investors, LLC
Jeffrey C. Scott, CFA, is chief investment officer at Wurts & Associates, where he is also head of the firm’s discretionary asset management division. Previously, he served as chief investment officer at the Alaska Permanent Fund, where he led the fund in adopting a risk-factor approach to asset allocation and in developing a risk-based investment policy. Institutional Investor awarded Mr. Scott the 2011 Outstanding Industry Contribution Award for the hedge fund industry. He has also worked as an assistant treasurer at Microsoft Corporation. Mr. Scott is a member of the long-term investor council of the World Economic Forum and served as a visiting scholar for Stanford University’s Collaboratory for Research on Global Projects. He holds a bachelor’s degree in finance from the University of Idaho and an MBA from Central Michigan University.
- “Allocating to risks” and positioning client portfolios to weather an uncertain macro environment
- Stress testing portfolios and enhancing diversification based on economic regimes
- Improving governance, manager selection, and perspectives on risk
My session notes follow. As always, these are contemporaneous notes. I make no guaranty as to their accuracy or completeness.
Optimization isn’t possible forward-looking
Problems with the status quo:
- Lack of diversification (they lean – recency bias; home country bias)
- Finding the right approach (buy and hold; mean-variance optimization; Black-Litterman model; endowment model; risk parity; programmatic tail risk hedging; risk allocation strategy) – none works all the time or in all situations
- Rebalancing – risk allocation better than asset allocation?
- Large drawdowns – nine years @ 10% plus a 30% loss = 5.14% annualized.
- Investment Principles (humility) – diversification; risk management (easier to manage than returns); valuation – because we cannot forecast the future accurately.
- Investment Philosophy – asset allocation drives approximately 90% of a portfolio’s risk and return characteristics
- Investment Approach – diversification of beta exposures (89% equity risk; currency risk (#2); interest rate; credit; inflation); alternative risk premia; “alpha” strategies
Risk Premia Diversification – for each of the five primary risks (avoid excessive specificity); when portfolio is diversified, one data point (even a big one, such as a major US stock drawdown) doesn’t tell you much about your portfolio; a managed risk portfolio is much more efficient
Risk Rebalancing Strategy – manage risk through dynamic asset allocation with tail risk insurance (volatility management)
Tail Risk Management – multiple choices; likes active direct and active indirect best; it’s an asset allocation decision; need to be opportunistic to lower costs; markets rising while vol is rising is a signal to pay attention to; buy hedge when vol is low; try to make money in bad markets via tail risk hedging and use the returns to invest more broadly at (much) cheaper prices
Risk-Based Investing – active risk budgeting and tail risk management
- Risk and volatility are not the same thing (e.g., peer and career risk)
- Fee budgets aren’t unlimited, so there are practical difficulties
- Risk parity a good foundation, but can’t go all in there (drawdown risk) – need alternative beta too
- Always hedge
- What about liquidity risk (not on his dashboard)? It’s critical (but not in this presentation); open Q about whether a true liquidity premium exists, but he thinks it comes and goes
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