Today’s report on US employment reaffirms that slow and slower growth has taken root in the labor market. Companies added a modest 142,000 workers in October, down from an upwardly revised increase of 188,000 in September, according to this morning’s update from the Bureau of Labor Statistics. But the main event in today’s release is the year-over-year advance, which slipped to the softest pace since 2011.
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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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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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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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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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