Controlling risk by optimizing portfolios
Traders and portfolio managers are operating in an increasingly risky environment. But risk doesn’t have to be the enemy if one takes the right steps.
In a recent webinar, “Control Your Risk: Optimize Your Portfolios!,” Alper Atamturk, Kaspar Dardas and Chris Lachmann, Bloomberg portfolio and risk specialists, explained how investors can better manage risk by tailoring investment portfolios to specific criteria, taking steps to guard against interest rate hikes, and overlaying portfolios with hedges while still generating strong risk-adjusted returns.
In many active portfolio strategies, while fundamental and market-driven security, sector, country selection and scoring are major areas of emphasis, portfolio risk management is often overlooked or considered as an afterthought. However, tactically controlling the portfolio risk can increase the risk-adjusted performance substantially.
The webinar contains six equity and fixed-income case studies demonstrating how to better manage risk through Bloomberg’s Portfolio Optimizer in addition to an overview of Bloomberg’s Portfolio & Risk Analytics Platform PORT<GO>.
Tailoring to specific criteria
Bloomberg’s Portfolio Optimizer allows traders and portfolio managers to create, rebalance and overlay portfolios to meet their specific goals, mandates and compliance requirements.
Common reasons to optimize a portfolio include:
- To manage and hedge risk.
- To generate trade ideas.
- To target exposures to meet specific goals and mandates.
- To efficiently manage money inflow & outflow.
- To track broad indices with liquid securities meeting compliance requirements.
Protecting portfolios against interest rate hikes
One of the risks portfolio managers face is the prospect of the U.S. Federal Reserve raising interest rates early next year. While no one knows for sure if or when it will happen, expectations of a rate increase tend to pressure bond funds. However, investors don’t have to see their portfolio take a hit if they optimize it against the risk.
For example, take a sovereign bond fund that has a duration longer than the benchmark it is tracked against. The portfolio would underperform in an environment of higher interest rates because of its excess sensitivity toward longer-term rates. But by optimizing the portfolio’s (active) duration and partial durations with bonds or futures overlays, the manager can reduce the impact an interest rate hike would have on the portfolio and effectively immunize the portfolio.
Taking the right risk
While having a low-volatility portfolio will protect investors when the stock markets are in a downturn, that same portfolio can underperform when times are good. That is because low-volatility portfolios often have a high concentration in defensive sectors, such as consumer staples, utilities, and health care, which tend to do better in down times. But those sectors tend to lag the performance of the markets when stocks are moving higher. Traders and portfolio managers, however, can use Bloomberg’s portfolio optimizer to tailor the portfolio so that it can provide protection in a downturn but not lag in an upturn, by appropriately dialing the risk between minimum volatility and market volatility. In other words, one can achieve the best of both worlds without taking unintended large sector bets.
An ongoing effort
To manage the risk inherent in all investment portfolios, traders and portfolio managers can optimize their investments on a recurring basis, rather than set them and let their original idea play out. Risk is everywhere. By optimizing the portfolio to manage against a market downturn, upturn or a rising interest rate environment, portfolio managers can see their investments grow while still controlling risk tactically.