Market volatility has been shaking up pension funds and managers looking for a smoother ride are turning to risk-weighted indices in order to optimise their portfolios.
Risk-weighted indices offer a way to resolve these concerns. Then you had specific objectives, such as minimum volatility or improving. There are two types of indices: It is not changing the stocks but the weight assigned to each of them. MSCI risk-weighted index series, launched in , takes MSCI indices and reweights them using risk to determine the weight, rather than using market capitalisation.
The underlying idea is powerful; instead of using equal weights we use equal risk to determine the weight and do that by putting more money into low volatility stocks. He acknowledges that relative to the traditional indices, use of risk-weighted alternative strategies is still low; there are trillions of dollars invested in the traditional indices. However there are a number of new clients in the early stages of adoption, such as pension funds.
The appeal is the softening they can provide of market shock. So cost considerations are a driver. There are a number of factors that will mean the take-up is not as great as for market-cap weighted indices. The two main issues are liquidity and size. The success of the mainstream index benchmarks is closely tied to the liquidity that is provided around them on the derivatives exchanges, for example, the EURO STOXX 50 futures and options are among the top five globally traded derivatives contracts by volume.
Sippel observes that if too many investors were to follow a specific strategy, all the assets would flow towards that strategy, and market-cap weighted indices and strategy indices would coincide.
However these strategies are not intended to replace more general approaches and their use should be considered in concert with the effect that investors are trying to achieve.
They are all trying to achieve the same thing, with strategies claiming to reduce volatility by about a third. There are costs associated with using alternative indices and as Krieg observes turnover is likely to be much higher than for standard indices.
Of course there are risks. It replicates an investment strategy, and as with any strategy it may go through multi-year periods where it is underperforming the market. There will be other periods like that; historically over long horizons these perform well. Performance should not be taken out of context, says Gunthorp, as some strategies such as minimum volatility do not have a return objective and are not in principle designed to outperform, or beat a cap-weighted benchmark.
So it becomes more of an art than science. You must be logged in to post a comment. Jamie , April 1, Jamie About the author. Lynn Strongin Dodds After being a target of abuse for so many years, it must have been heartening for the high freq Leave a Reply Cancel reply You must be logged in to post a comment.
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