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Alternative beta
Risk premia investing that is more targeted in nature than broad market beta.
1
Contents
Introduction 3
Contact 19
Contributing authors
Art Gresh
Adam Jokich
Andreas Razen
Patrick Zimmermann
UBS 2016. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.
2
Introduction
One could argue then that alternative beta has been a feature of some
quantitatively managed investment strategies for quite some time. Where
alternative beta differs from its active, quantitatively managed counterparts,
is in its level of transparency. Put simply, this takes the form of simple rules-
based methods for portfolio construction or, in an analogy to traditional passive
investing, indexing by a means other than market capitalization. Indeed it is in
part the relative simplicity and transparency of the alternative beta approach
that has led to its adoption by an increasing number of investors.
What follows is our attempt to explore these questions and present them
within the context of three examples. Each has been selected in response to
specific client queries. We do not contend that what we present is an exhaustive
treatment of the subject. Rather we hope it will be illustrative of our approach
to the topic and UBS Asset Management's contribution to the discussion.
The first paper focuses on what is perhaps the most well-known and
thoroughly studied factor, premium:value. Both practitioners and academics
have devoted considerable effort to:
In the case of the latter, testing alternative rationales for the existence of
the value premium.
3
That said, it is the apparent persistence of the value premium across markets
and asset classes that has resulted in its emergence as one of the largest asset
categories in the alternative beta space. The research here examines the value
premium in the equity market, specifically focusing on how the premium is
measured and how the resulting indices are constructed.
Our research indicates that the methods typically employed by most index providers
can be improved upon with relatively modest effort. In particular, we find that
measuring value using customized metrics that reflect the specific industry / sector
dynamics and structure leads to superior results compared to techniques typically
employed by most alternative beta index providers where an almost identical list
of metrics is used for each and every sector. The fundamental insight here can
be simply stated by way of an example: Utility companies are very different to
Technology companies so why would we use the same metrics or ratios to measure
value in both of these sectors? A superior approach is to use our fundamental
understanding of these sectors to develop sector specific metrics that better
measure and capture the value premium.
Our second paper examines the factor risk premium that rivals, if not exceeds, value
in terms of asset flows and client interest low-risk. In particular, we focus on the
variant of the low-risk premium termed 'Minimum Volatility'. Minimum Volatility
investing has expanded dramatically in the years following the Financial Crisis
and while the desire on the part of investors to mitigate losses is understandable
given the searing experience of Autumn 2008, we question whether a Minimum
Volatility strategy is the best means of securing this objective.
Empirical evidence demonstrates that returns are more extreme than what
can be supported under the assumption of log normality, as the following
papers will highlight.
Finally, the nature of the volatility statistic makes it at best a partial solution to the
investor's problem of minimizing drawdown. Volatility is a symmetric measure.
A process that minimizes volatility not only reduces downside potential but also
reduces upside potential.
4
In order to address investors' concern over loss mitigation, we propose
constructing a portfolio around a risk measure that better captures the non-
linearities and non-normality of the distribution of stock returns. The measure
we use is Expected Tail Loss (ETL). ETL allows us to estimate the features of
the distribution that cannot be adequately captured using volatility. The richer
measure of risk that ETL affords allows us to better target portfolio drawdown
risk. Additionally, ETL has the benefit of not explicitly compressing the exposure
to the upside of the distribution. Our simulation results show the ETL approach
achieving superior risk adjusted returns and lower drawdowns than those
achieved using Minimum Volatility.
The third paper is an example of how an investor might use alternative beta
strategies as building blocks in a multi-asset portfolio. Where our previous
discussion has focused exclusively on equities, this piece of research introduces
additional sources of alternative beta from fixed income, foreign exchange
and commodities. The alternative beta elements form the core of the portfolio
in much the same way as conventional market capitalization indexed passive
strategies often form the components in a traditional asset allocation strategy.
Construction of the core portfolio is governed by a modified risk parity
approach where the marginal contribution of each factor's risk component
is equalized subject to a risk budget constraint at the asset class level (e.g.,
50% fixed income, 40% equity and 10% commodities).The paper then goes
on to explore ways that the core portfolio can be improved by a series of
enhancements. The most relevant of these enhancements in terms of alternative
beta premia is the introduction of macroeconomic tilts. The tilts imposed are
a function of the macroeconomic cycle and take the form of deviations from
the core risk parity portfolio aligned with that cycle. As an example, while in
the recessionary phase of the cycle the portfolio would tilt toward Minimum
Volatility and equity yield factor premium.
The work presented here is just one of many potential alternative beta
applications in the multi-asset context. For those interested in learning more, we
encourage you to read the individual papers. We hope you find them useful in
framing your own questions, and answers, on the appropriate use of alternative
beta strategies in your portfolio or that of your clients.
Art Gresh
Managing Director
UBS Asset Management
5
Building smarter value equity strategies
In recent years, investors have begun to explore Introducing industry specific metrics
systematic approaches to capture what has come to Given the above, a natural extension of current practice
be termed 'the value premium'. In an effort to harvest is the introduction of industry specific valuation metrics,
the observable value premium in the market, nearly ones that better reflect the idiosyncrasy of each industry
all large index vendors have devoted resources to the structure. Consider Financials, a sector that contains
development and marketing of value indices. In general industries with differing market cycle dynamics. For
these indices are of two broad types. The first utilizes example, the revenue stream and capital requirements
the concept of fundamental weighting which derives of Real Estate companies are significantly different to
constituent weights from the underlying company those of Insurance companies.
fundamentals. The rationale behind fundamental
weighting is that over the long term, weighting the Going a bit deeper, let us examine the construction
universe by fundamental measures, rather than prices, methodology of the value score used by MSCI in the
will guard against market bubbles and crashes as construction of their MSCI Enhanced Value suite. These
deviations between fair price and fundamental value indices use an equally weighted average of the forward
can be long-lived. These types of strategies employ Price to Earnings (P/E), Enterprise Value (EV) to Cash
a combination of sales, operating cash flow, uses of Flow from Operations (CFO), and Price to Book Value
cash, and book value to determine the weight of the (P/B) in the computation of the composite value score,
company in the index. By construction, fundamental with the exception of the Financials sector. Within the
indexing has historically exhibited a tilt towards value Financials sector, companies are measured based on
versus its capitalization weighted universe. forward Price to Earnings (P/E) and Price to Book (P/B).
While all three components have been shown to exploit
The second method directly incorporates price level different aspects of a company's value, these signals
valuation ratios for the security selection and index should not be applied uniformly across the market. For
construction process. In practice, this approach is example, the P/B ratio tends to work well when firms
typically implemented by first computing a composite have large amounts of fixed assets on their balance
value score for each company using valuation metrics sheet, however, the efficacy of this ratio will suffer
such as price to earnings and price to book value. when companies have large, intangible assets (e.g.
The index constituents and their respective weights brand names, patents).
are then determined largely by a security's market
capitalization and value score. A value tilt is a natural These observations lead to the question: How well
by-product of the relative value metrics employed in does the MSCI Enhanced Value methodology identify
the security selection and index construction process. over or undervalued companies, using the three
The primary objectives of these indices are to maintain aforementioned factors uniformly across all sectors?
a significant exposure to value, while also aligning
closely with its capitalization weighted index. To
achieve both objectives, constraints may be imposed
when constructing the index, such as target holding
counts and sector neutrality relative to its capitalization
weighted index (i.e. zero active sector bets).
6
Figure 1 to Book (P/B) and Forward Earnings Yield (E/P) have
MSCI Financials Valuation Signal persistently proved to add value across the Financials
Monthly returns for the top 25% of companies (most attractive) in the MSCI World Index
based on their valuation score, versus the bottom 25% of companies (least attractive) in
sector and broader global equity markets. The two
the MSCI World Index. The valuation scores are calculated using the same methodology aforementioned factors provide a base for valuing Banks
used to constructed the MSCI World Enhanced Value Index, which is an equally weighted
average of the forward Price to Earnings (P/E) and Price to Book Value (P/B) value. and Insurance companies. Specifically, Price to Book is
a critical measure in assessing the value of a company
160
within these industries. Given much of their value is
140 derived from capital markets, they are required to mark-
to-market their assets and liabilities on the balance
120 sheet, which gives investors an accurate assessment of
shareholders' equity at fair value.
100
80
However, within the Diversified Financials and Real
Estate industry, Price to Book (P/B) proves to be of less
60 importance. Unlike Banks and Insurers, the assets and
liabilities for Real Estate companies are not liquid, and
40 prices are not readily available in the capital markets;
this requires investors to carefully scrutinize Price to
20
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Book ratios across companies as the book values may be
distorted.
Top 25% Wealth relative Bottom 25%
Source: UBS Asset Management. For details of computation see footnote 1 on page 10.
Further, much of the Real Estate industry, specifically
See disclosures for important information regarding simulated results. REITs, are heavily regulated and forced to distribute a
large portion of earnings to shareholders. As a result,
Figure 1 presents the results of a simple back-test where the current dividend yield and sustainability of the
we attempt to answer this question. Using the MSCI dividend policy are critical in assessing the value of REITs.
Enhanced Value methodology, and the MSCI World Monitoring the ongoing operating cash flow through its
Index as our universe, we create two equally weighted reported Funds from Operation (FFO) is a more accurate
portfolios based on their assigned value score, one of measure of a REIT's sustainable profitability than the
the top quartile (under-valued), and one of the bottom standard Cash Flow from Operations (CFO). Specifically,
quartile (over-valued), and plot their respective returns the latter often includes many one-time items, such as
over time. With approximately 1,600 companies in the gains / losses from the sale of property and reported
MSCI World Index, selecting the top quartile provides changes in the equity positions of unconsolidated
adequate breadth within each sector, and is well aligned entities. The NAREIT definition of FFO strips out these
with the MSCI World Enhanced Value Index target non-recurring and / or non-cash line items, allowing
of 400 companies. We also plot the wealth relative investors to better ascertain the ongoing cash earnings
line (i.e., the difference in return between the top from the real estate business. Additionally, given the
and bottom 25% of companies, based on their value capital intensive nature of the Real Estate industry, we
score). Examining the results we see little difference in believe EBITDA Yield gives a clearer reflection of the
the performance of the top and bottom 25% of the business operations when compared to Earnings Yield,
distribution. as it is irrespective of the financing and depreciation /
amortization decisions.
These results suggest an industry specific mapping may
be merited. Our approach draws upon the knowledge Lastly, as mentioned above, dividend policy is critically
of our global fundamental analysts. We use their important in valuing companies in the Real Estate
understanding of the industry dynamics to identify the industry, but total yield, which includes net share
appropriate metrics for each industry in the Financials buybacks, is more suitable for Banks and Insurance
sector. The Financials sector is comprised of industries companies, given their preference and history of share
with significantly different business models and thus, buybacks.
each should be valued using valuation metrics that are
specific to that industry. Like MSCI, we believe Price
7
With these customized industry specific valuation Figure 2
measures we repeat the analysis we presented above. UBS Financial Valuation Signal
The results of this exercise are presented in Figure 2. Monthly time series of returns for the top and bottom 25% of the sorted Financials sector
based on UBS scoring methodology customized for the Financials sector. Portfolios are
Inspecting the results we now see better separation indexed to 100 as of December 31 2007 and tracked through to April 30, 2016.
Source: UBS Asset Management. See disclosures for important information regarding
simulated results.
Figure 3
Return Spreads for Financial Signals
Distribution of monthly return spreads between the top and bottom 25% of the sorted
sector. Returns are from December 31, 2007 April 30, 2016
Number of months
50
40
30
20
10
0
-10 -8 -6 -4 -2 0 2 4 6 8 10
8
Next, we extend the industry specific approach across Figure 4
all MSCI GICS Sectors in the MSCI World Index to Return Spreads for the well-diversified portfolios using MSCI World
create a well-diversified portfolio of the top 25% (most Enhanced Index methodology and UBS AM methodology
Distribution of monthly return spreads between the most attractive (top 25% under-
attractive based on valuations) and bottom 25% (least valued) and least attractive (bottom 25% over-valued) well-diversified portfolios. Returns
attractive based on valuations) of companies in each are from December 31, 2007 April 30, 2016.
Figure 5
Well-diversified portfolio
Monthly time series of well-diversified portfolios. Well-diversified portfolios are created by aggregating the top and bottom 25% of companies in each MSCI GICS sector based on valuation
using the UBS AM and MSCI Enhanced Value Index methodology. Portfolios are indexed to 100 as of 31 Dec 2007and extend until April 30, 2016
160 160
140 140
120 120
100 100
80 80
60 60
40 40
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Top 25% Wealth relative Bottom 25% Top 25% Wealth relative Bottom 25%
9
Conclusion
This study examines some potential limitations of off-
the-shelf / one-size-fits-all products that seek to capture
the value premium. Careful consideration should be
placed on metrics used to measure value and the
process of signal construction. It is imperative to realize
that for strategies attempting to take advantage of the
value premium, the input signals need to be defined in
a manner that will segment the market effectively as
no portfolio construction technique will compensate
for inefficient underlying signals. The value premium
still exists, but as the market evolves, smarter signal
construction is necessary in order to capture it.
Table 1
Return Spreads Summary
Annualized returns comparing the methodology used by the MSCI World Enhanced Value Index and UBS AM. Returns are an equal weight of the top 25% (most attractive based on
valuation) and bottom 25% (least attractive based on valuation) of companies in each sector. The well-diversified portfolio is an equally weighted sector portfolio. The returns are from
December 31, 2007 to April 30, 2016.
1
S imulation is based on a subset of equity constituents in the MSCI World index, in USD, gross of fees and transaction costs. Simulated portfolio was rebalanced monthly. The dividend
criteria used for stock selection is net of non-reclaimable withholding tax dividend yields from a Luxembourg domiciles perspective, but returns are based on total returns. Simulation is
hypothetical and does not represent a live track record or actual returns realized by any investor. Past performance, whether simulated or actual, is not a guarantee for future performance.
See disclosures for additional information.
10
Minimum expected tail loss equity portfolios
1
Tversky & Kahneman (1991) "Loss Aversion in Riskless Choice: A Reference-Dependent Model" The Quarterly Journal of Economics
2
Xiong, J. (2010) "Nailing Downside Risk" Journal of Risk Management
11
Introducing Expected Tail Loss value when 5% of the distribution is to the left. The ETL
We propose a risk measure for use in portfolio value is the expectation or average of the distribution
construction that does not face the issues and to the left of the VaR. One note about semantics, in the
limitations of minimizing volatility described above. example we used the cash value of the loss, but this
The ideal measure would neither require symmetry nor can also be expressed in return space, which we did for
assume normality and should be robust during market Figure 1 and continue to do for the rest of the note.
downswings in an attempt to prevent drawdown.
ETL is calculated by averaging the losses that are beyond
Expected Tail Loss (ETL), which is an extension of the a certain threshold of a portfolio return distribution.
commonly used Value at Risk (VaR) statistic, fits these There are many ways to create the distribution, but
requirements. Recall, VaR is a threshold statistic defined the simplest is to use the empirical portfolio returns.
as the minimum amount of portfolio loss at a specified The minimum ETL portfolio optimization finds the
probability and horizon. For example, a particular combination of portfolio weights that result in the lowest
portfolio might have a 5% VaR value of USD1 million. ETL value (by summing the weighted individual asset
This means that 5% of the time the portfolio will lose return distributions). Minimum ETL portfolio construction
USD1 million or more in a specified time horizon, say uses every past return to capture co-movement of assets
over a month. VaR does not, however, tell the investor and does not suffer from the issues associated with a
how much on average they can expect to lose when correlation estimate based upon a return distribution
losses exceed USD1 million. This is the information that assumption. Upside reduction due to symmetry also does
the ETL statistic can relate. not exist for ETL because the statistic focusses purely on
the loss side of the distribution. Additionally, assumptions
ETL is also a threshold statistic that has as its basis of normality are not needed with ETL; the optimization
VaR. ETL is defined as the expected amount of process uses every observation of the asset return data
portfolio loss at a specified probability level. Instead within the specified historical window to model the left
of using VaR and knowing that the portfolio will lose side fatter tail in the distribution. Most importantly the
at least USD1million 5% of the time, using the ETL concept of ETL is in line with the investor's true objective,
measure will tell us that we expect to lose on average reducing portfolio loss and not just portfolio uncertainty.
USD1.2million 5% of the time. Figure 1 shows this In simulations it yields more attractive risk adjusted
graphically using a histogram of portfolio returns. The returns and lower drawdowns than its minimum volatility
VaR value, represented by the dotted line, is the return counterpart.
Figure 1
Calculating VaR and ETL: Value at Risk represents the minimum amount
of loss that will happen x% of the time. Expect Tail Loss represents the
expected amount of loss that will happen x% of the time.
35
Count VaR
30
25
20
15
10
5 ETL
0
-10% -9% -8% -7% -6% -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5% 6%
Monthly return
12
ETL versus Minimum Volatility: the capitalization weighted benchmark, not only in
Comparative backtest simulations annualized returns but also across other performance
There is a considerable body of research demonstrating metrics; it has lower maximum drawdown, lower ETL,
the advantages of using ETL in the asset allocation and even lower realized volatility, leading to a portfolio
space. In contrast, applications to stock only portfolios with greater annualized risk-adjusted returns. It closely
have been limited due to computational burdens. matches the performance of the MSCI Minimum
However, improvements in computer processing power Volatility during the down months and outperforms
and advancements in mathematical programming during the up months leading to greater wealth
techniques have made large scale problems accumulation.
computationally feasible.
Conclusion
We compare the ETL and minimum volatility approaches When adding a low risk strategy to an investor's
over the period January 2000 December 2014. For portfolio it is important that the strategy captures the
the minimum volatility portfolio we select the MSCI investor's actual risk objective: wealth preservation.
USA Minimum Volatility Index. The ETL portfolio is Minimizing volatility lowers uncertainty about portfolio
constructed using the same universe of MSCI USA outcomes, but for many reasons is not designed to
Index constituents that MSCI uses in constructing reduce long term losses. ETL addresses the shortcomings
their minimum volatility index. In order to improve of minimum volatility by not assuming symmetry
comparability we impose the same constraints on the and focusing on the loss side of the portfolio return
ETL portfolio optimization as those imposed by MSCI distribution. After creating an ETL backtest simulation
in constructing their minimum volatility index. The ETL with similar constraints to the MSCI USA Minimum
portfolio is minimized at a 10% threshold. Volatility index, the outcome and resulting portfolio
characteristics are encouraging. Certainly investors
The minimum ETL simulation results in Figure 2 and should consider an ETL approach as an option when
Table 1 include estimated transaction costs. The evaluating low risk investment alternatives.
ETL portfolio is preferable to minimum volatility and
Figure 2 Table 1
ETL vs MSCI Minimum Volatility: 14 year backtest for the Minimum Factor Tilts in Economic Regimes
ETL strategy, compared to the MSCI USA Index and MSCI Minimum
Asset Minimum MSCI Minimum
Volatility Index.
ETL USA Volatility
Cumulative returns (%)
Annualized Returns 7.1% 3.9% 6.6%
200
Annualized Volatility 11.1% 15.4% 11.8%
-50
2000 2002 2004 2006 2008 2010 2012 2014
Minimum ETL MSCI USA Minimum Volatility
13
Tactical tilts and multi asset class risk premia
1
Respectively proxied by the Deutsche Bank Impact Dollar Rates 3M and Goldman Sachs Volatility Carry strategy.
2
Note that the data for alternative beta starts late, their weights are equal to 0 up to 5 years after the data become available.
14
In Table 1 we provide the summary statistics of the risk The tactical tilts we propose are comprised of two
premia portfolio and the benchmark3. The risk parity components:
portfolio generates a higher risk-adjusted performance
over the entire sample, with less volatility due to A momentum strategy, including both cross-sectional
diversification across factors. and time series momentum, with a signal constructed
over the previous 3, 6, 9 and 12 months with more
emphasis on the longer time windows for stability
Table 1
Summary Statistics A macro based strategy that applies fixed tilts to
Benchmark Risk Premia each asset based upon the state of the economy
Sharpe 3yrs 1.51 1.48
5 yrs 1.32 1.58 Including momentum enables the capture of shifts that
are typically not detected by fundamental variables,
10 yrs 0.61 0.66
as well as identifying time-varying risk-aversion. In
since 1989 0.47 0.67 constructing the macroeconomic trading rule we use only
Avg Return (%, ann.) 3.76 3.69 one indicator, the OECD composite leading indicator (CLI),
Std Deviation (%, ann.) 7.91 5.52 and classify the regime or state of the economy based
Max Drawdown (%) -29.17 -22.11
upon two dimensions: (1) its 3-month rate of change and
(2) its level.
Skewness -0.66 -1.13
Kurtosis 4.70 6.95 Regime classification is done out of sample, using the
Source: UBS Asset Management latest available release each month. This indicator may
See disclosures for important information regarding simulated results.
be viewed as a base-case indicator given that there is a
2-month lag in the release of the latest data. Depending
Introducing tactical tilts: upon whether the economy is growing (e.g. positive
The macroeconomic cycle and momentum 3-month change), and whether it is above average (e.g.
There is considerable evidence that asset returns or risk- level above 100), the regime is classified as being in
premia are not constant through time, nor are correlations recession, recovery, expansion or slowdown.
static. For instance, bear markets are characterized by high
correlation across risky asset classes and a flight to quality. In order to address concerns over 'noise regime shifts'
Observations like these have given rise to numerous studies and its attendant portfolio turnover, we impose a 'no-
on conditional asset allocation, whereby the composition change' band so that unless the indicator has crossed
of a portfolio depends upon the 'state' of the economy, the 40% or 60% percentile (computed over past
or underlying risk regimes. It is beyond the purpose of observations) we classify the current regime as being
this note to present a survey of these studies, but a few identical to the one the previous month. Figure 2 provides
preliminary observations are necessary. a graphical representation of how we classify regimes.5
During recessions, portfolio tilts are conservative. We
Generally, the time series predictability of these overweight US government bonds and reduce allocation
approaches has been found to be low but consistent with to high yield and investment grade. In equities, we increase
expectations, given the inherent difficulty of the task. the allocation to minimum volatility and quality while
However, in recent research Neely et al (2012)4 note that reducing momentum and the allocation to alternative beta.
macroeconomic and technical indicators both tend to During recoveries, we tilt the portfolio in a more aggressive
capture counter-cyclical information, but at different points direction. Previous research suggests that tilts tend to be
of the cycle: Technical indicators tend to detect the typical more successful in recessionary environments and that
decline in the equity risk premium near business cycle it may be difficult to distinguish between recoveries and
peaks while macroeconomic variables more readily pick up expansion, or between slowdown and recessions. We
the typical rise in the equity risk premium later in recessions simplify and assume less confidence for slowdown regimes
near cyclical troughs. This observation leads us to consider (e.g. tilts are half than during recessions), and are identical
an approach that combines macro and technical based during recoveries and expansions. This leaves us with three
indicators. regime-dependent allocations.
3 We assume it to be 50% MSCI World and 50% WGBI. Returns are annualized and in excess of cash (i.e. US 3 month Libor).
4
Neely, C.J., Rapach, D.E., Tu, J., Zhou, G, (2012), "Forecasting the Equity Risk Premium: The Role of Technical Indicators", Working paper, Federal Reserve Bank of St. Louis.
5
Note that the graph, for ease of representation, is based upon the latest release whereas in the practice each data point pertains to its release date at the time.
15
Figure 2
Regime Classification
0.3
Strength Negative Strength Positive
Momentum Positive Momentum Positive
Momentum: Pace of change
Recovery Expansion
Mar-13 Sep-13 Dec-10
0.1
Dec-12 Dec-13
Jun-13 Jan-15
Mar-12 Dec-14 Mar-14
Nov-14 Mar-11
Dec-11 Sep-14 Jun-14
Sep-12
-0.1 Jun-12
Recession Sep-11 Slowdown
Jun-11
Strength Negative Strength Positive
Momentum Negative Momentum Negative
-0.3
99 100 101
Strength: Relative to trend-growth
Table 2 summarizes these portfolio tilts. On average, we Combining risk parity with tactical shifts
have one portfolio tilt a year. The magnitude of the tilts is and momentum
small and the realized volatility of the resulting portfolio The final portfolio is a combination of three
below our target of 5%. In what follows we rescale the components: the risk-premia portfolio, the momentum
weights obtained to reach a target volatility of 5%. strategy and the tactical macro tilts.
Commodity Carry 2% 2% 0% 0%
Sum 0% 0% 0% 0%
Source: UBS Asset Management
See disclosures for important information regarding simulated results.
16
Figure 3 Table 3
Cumulative Returns of the Strategy Components Summary statistics
140 Risk Macro Mom- Comb-
Premia Tilts entum ination
120
Sharpe 3 yrs 1.50 -0.17 1.23 1.47
100
5 yrs 1.53 0.10 0.86 1.46
80
10 yrs 0.86 0.46 1.33 1.18
60
since 1989 0.72 0.37 0.92 0.88
40
Avg Return (%) 4.24 2.09 5.21 3.36
20
Std Deviation (%) 5.86 5.73 5.63 3.84
0
Max Drawdown (%) -18.35 -17.95 -9.76 -5.40
-20
1989 1994 1999 2004 2009 2014 Skewness -0.33 0.64 0.06 0.16
Benchmark Risk parity Macro tilts Momentum
Kurtosis 5.07 6.20 6.44 4.64
Source: UBS Asset Management Source: UBS Asset Management
See disclosures for important information regarding simulated results. See disclosures for important information regarding simulated results.
We form an aggregate portfolio by assigning 50% of The strategy exhibits flat returns in 2008 as losses in the
the weight to the risk-parity portfolio, 25% to macro core portfolio were offset by the gains in momentum
tilts strategy and 25% to momentum strategy. We and macro-based strategies. Momentum and risk-
constrain portfolio weights to be positive and gross parity strategies achieve the highest risk-adjusted
leverage not to exceed 1. Because of these controls performance over the whole sample. As expected
and the low correlation of the three components, the from a low-turnover strategy, the performance of the
realized volatility of the portfolio falls just under 4%. macroeconomic strategy is much weaker, especially in
In Table 3 we provide the summary statistics for three the last five years given that most of this time period
components and their combination in the final portfolio. was spent in recovery, a regime where tactical tilts tend
Cumulative returns are shown in Figure 4. to underperform. However this component has a 0%
correlation with risk-parity and 30% with momentum,
hence contributing to diversification. The combination
Figure 4 exhibits a more stable risk-return profile through the
Cumulative Returns of Aggregate Portfolio entire sample and positive skewness5. Fat tails, as
1.0 measured by kurtosis, are less pronounced. Finally, the
ratio of maximum drawdown to standard deviation is
0.8 more favorable.
-0.2
1989 1994 1999 2004 2009 2014
Benchmark Combination
Source: UBS Asset Management 5 Please note that Sharpe ratio and other statistics for the risk premia portfolio slightly
See disclosures for important information regarding simulated results. differ from those in Table 1 because the portfolios in Table 3 have been rescaled to
achieve an out of sample target volatility of 5%.
17
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the dissemination of investment research. Switzerland investors: This document has been issued by UBS AG, a company registered under the Laws of Switzerland. This commentary contains
simulated results prepared by UBS Asset Management. The simulated results are presented for illustrative purposes only. Simulated results are developed with the benefit of hindsight and
have inherent limitations. The analysis contained herein is based on historical analyses and numerous assumptions. Different assumptions could result in materially different results. The
simulated results do not represent actual trading using client assets and are not based on the results of any actual strategy managed by UBS Asset Management. Investors should not take
the example herein as an indication, assurance, estimate or forecast of future results. Actual results may differ materially from the simulated results shown. Simulated results may not reflect
the impact that material economic and market factors might have had on UBS Asset Management decision making if actual client assets were managed during the time periods portrayed.
No representation is being made that any strategy will achieve results similar to the simulated performance shown in this commentary. The simulated performance is presented gross of
investment management fees. Actual returns would be reduced by advisory fees and other expenses incurred by the client. UBS 2016. The key symbol and UBS are among the registered
and unregistered trademarks of UBS. All rights reserved.