Morningstar Magazine - October/November 2016 - 44

0 Spotlight: Risk factor, a proprietary Morningstar factor. The model signals a decrease in variance and a similar decrease in VAR and CVAR six and 12 months out. This implies that the longer-term return distribution has shifted toward the positive expected returns with less risk. Additionally, this pattern appeared for funds highly exposed to the growth end of the value-growth spectrum. -50 -25 Variance Skewness Kurtosis Value at Risk Conditional Value at Risk -75 -50 Variance EXHIBIT 7 Skewness Kurtosis Value at Risk Conditional Value at Risk -75 Risk: Economic Moat The model showed a decrease in variance, VAR, and CVAR, implying a shift toward positive expected returns with less risk. Period 1M 3M 6M 1Y Median Delta (%) Period 1M 3M 6M 1Y 20 Median Delta (%) 200 Last, E X H I B I T 8 visualizes the short-term (one month) and long-term (one year) forecast risk statistics for Dodge & Cox International Stock. Comparing its post-Brexit forecast with the pre-Brexit one, the risk model finds increased variance, skewness, and kurtosis while signaling decreased VAR and CVAR. This suggests greater return volatility paired with higher expected return in the year ahead for the fund. -200 -20 -40 Variance Through the Morningstar Global Risk Model, we have demonstrated the unique analysis that risk modeling can bear upon global events. Risk modeling decomposes security risk and return into their primary drivers, or factors. This enables investors to examine multiple dimensions of their portfolio and strategically optimize their exposures. This capacity becomes critical as we encounter events in the world. Brexit has not yet concluded, with significant uncertainty remaining on triggering Article 50 and the negotiation process. The United Kingdom's move sparked European Union-exit sentiment in other European nations. The U.S. election arrives shortly. We will follow the global markets through the risk model and look forward to its insights. K James Li is a quantitative analyst with Morningstar. 44 Morningstar October/November 2016 Kurtosis Value at Risk Conditional Value at Risk -40 -60 Skewness Kurtosis Value at Risk Conditional Value at Risk -60 Source: Morningstar. Variance Using the Morningstar Global Risk Model Our analysis of the risk model's output reveals deeper insights into the market reaction to Brexit. We saw the rotation to defensive sectors, the recovery of the financial services sector, and the strengthening of the U.S. dollar. Uniquely, we found positive risk premiums for exposure to high volatility and low liquidity. Finally, we observed significant changes in forecast risk from before Brexit to after Brexit in funds highly exposed to financial services, developed Americas, and economic moat. Skewness EXHIBIT 8 Risk: DODFX The chart shows the fund's post- and pre-Brexit forecasts. It implies Variance Brexit Timeline greater return volatility but higher expected return Value over theSkewness next year. Value Before Brexit AfterTimeline Brexit Brexit 0.04 Value 0.010 Value 0.008 0.010 Variance Before Brexit After Brexit Skewness 0.04 0.03 0.006 0.008 0.03 0.02 0.004 0.006 0.02 0.01 0.002 0.004 1M 1Y 0.000 0.002 1M 1Y 0.01 0.00 Kurtosis Value 1M 1Y Value at Risk 0.000 Value 1M 1Y 0.00 Conditional Value at Risk Value Kurtosis 4 Value Value at Risk 0.0 Value Conditional Value at Risk Value 0.0 -0.2 0.0 -0.2 -0.2 -0.4 -0.2 -0.4 43 32 21 0.0 1M 1Y 10 1M 1Y -0.4 -0.6 1M 1Y -0.4 -0.6 1M 1Y 0 1M 1Y -0.6 1M 1Y -0.6 Source: Morningstar.

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