Morningstar Advisor - April/May 2013 - (Page 54)
Morningstar Conversation
Incorporating uncertainty is trying
to think through various states
of the world, to put a high primacy on
the fact that we will always have incomplete information, and
to treat the future with the humility it deserves.
Joseph Davis
do for our clients always is driving our views
of risk. Our value proposition to clients
is to provide a competitive return with less
risk than the typical equity-only fund or
equity benchmark.
That implies some particular characteristics
that we feel the portfolio must exhibit
for us to say we’re achieving client expectations. So in a weak market, our clients
expect, and we aim to deliver, a portfolio that’s
not down as much as the equity markets.
Then, in a period of recovery, we want to get
our client wealth, in terms of cumulative
total return, back to a new all-time high sooner
than the equity markets will do. So, a smaller
drawdown and a shorter duration between
periods of new highs in wealth have to
characterize the outcome for our clients for us
to be successful.
In terms of the models we use, they’re
proprietary BlackRock risk engines. Years ago,
we used industry-provided, off-the-shelf
risk engines that were then customized for our
particular portfolio. The shortcoming
of that was that we didn’t control the engine.
In particular for multiasset portfolios, the
industry has not done a good job at all. The
industry’s approach to risk is to build
models for equities and separate models for
fixed income.
So, BlackRock has a big risk-management
operation that services not only the
$3.7 trillion that we manage but approximately
another $10 trillion of client assets where
54 Morningstar Advisor April/May 2013
other investment managers and clients buy
our risk work. There’s a huge amount
of proprietary technology behind the risk
measures that we get.
What do we look at? The basics are what’s the
standard deviation of our portfolio, what
is the beta of our portfolio versus our benchmark, what’s the beta versus the S&P 500,
what’s the tracking variance or tracking error of
our portfolio—how does that look in
terms of the historic range, and how does that
marry with our particular qualitative views of
the environment?
In other words, do we believe that this is an
environment in which risk-taking will be
rewarded? In which case, we want some of
those measures higher, especially our
betas. Or is this a time of greater uncertainty,
where we don’t think there’s a particular
advantage to risk-taking in general or the
particular insights that we have?
So, that’s the range of measures. Then, the
techniques will include not only those
measures but the aforementioned scenario
analysis. We pick particular potential
events and shock the portfolios with those
events to see how they behave.
Davis: Risk management begins with the firm’s
culture and people. Vanguard’s unique
ownership structure, where we’re owned by
our clients, clearly aligns with very serious
attention paid to risk management. We
have a very deep investment risk-management
team, as well. John Hollyer runs a global group
where operational-risk and investment-risk
management are the primary objectives, and he
reports right to our chief investment officer,
Tim Buckley.
We have other groups, as well. Risk management is the primary area of focus, for example,
in our fixed-income department, managed
and run globally by Bob Auwaerter. We have a
whole portfolio review department that
oversees all of our actively managed funds.
Ultimately, all of these departments and
all our risk management are overseen by our
portfolio review group, which is led by our
chairman, Bill McNabb. Again, sitting
importantly at that table is Tim Buckley, our
chief investment officer.
So, risk management is at the fore of the
products and services that we provide
clients, and it’s truly embedded as a very high
priority with respect to constructing welldesigned portfolios.
One simple example is single-fund solutions
that we provide to plan sponsors and
individual investors in the form of, say, target
retirement funds. There, the objective
is clearly never to simply maximize return.
It is to look at how assets and portfolios
interact and, in many ways, to diversify
bad equity market outcomes, and to countervail
that sort of diversification property with
other risks that the investor may face—risks
such as longevity risk, inflation risk, and
so forth.
Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2013
Morningstar Advisor - April/May 2013
Contents
Contributors
Letter From the Editor
The Pursuit of Happiness and Financial Advice
What Strategies Do You Use to Control Risk?
Driven to Succeed for Clients and Family
How to Assess a Portfolio’s Bond Risk
Luck, Skill, and Investing
Investments á la Carte
Investment Briefs
Investing’s No- Brainers Have Costs
A Defensive Ride
Risk On/On Risk
The Risk of Being Overconfident
Year of Living Dangerously
The Risk-Parity Approach
A Guide to Mutual Funds Running Risk-Parity Strategies
What Moats Tell Us About Risk
Risk’s Wake-Up Call
Seeing Is Believing
Why Investors Lag the Returns of Their Funds
Liquidity Signals
Pump Them Up
Golden Oldies Keep on Truckin’
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Our Social Blind Spot
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