Christopher Carrano, VP of Strategic Research for Venn by Two Sigma, joined Julie Cooling, Founder and CEO of RIA Channel, to discuss a new approach to portfolio construction.
The traditional portfolio construction approach buckets allocations into asset classes. Unfortunately, asset classes are not always diversifying and may be concentrated in the underlying drivers of risk. This traditional approach is inherently siloed, with individual teams selecting managers and constructing portfolios within each asset class.
Rather than focusing on asset classes, the total portfolio approach focuses on the drivers of risk. This can help align the structure of the investment team and the analytic process. A factor lens is central to the total portfolio approach. For example, a 60/40 portfolio is concentrated in risk factors such as interest rates and equity risk. Having a large number of asset classes does not necessarily mean a portfolio is diversified from a risk perspective. That is, interest rate risk can be found in fixed income, equities, private credit, real estate, and other asset classes. The goal of rebuilding portfolios is to add exposure to independent and uncorrelated risk factors.
Venn by Two Sigma offers a subscription-based multi-asset portfolio analytics and reporting platform that calculates factor exposures of managers, indexes, funds, ETFs, and anything else with a return stream. The factor exposures calculated are the essential risks that seek to explain every investor’s portfolio. The results are similar to a nutrition label for food, which reports calories, carbohydrates, and fat without stating whether the food is meat or vegetables. Advisors can evaluate the factor exposures of portfolios and investments simply by using returns without knowledge of the underlying holdings. This regression-based approach identifies key drivers of risk and return for hedge funds, even without transparency of portfolio holdings.
Private investments can be even more challenging to evaluate, as returns are reported infrequently with a lag and may have artificially low volatility. Venn has purpose-built analytics that can put private asset returns on a level playing field with publicly traded assets.
Resources:
Incorporating a Total Portfolio Approach
From Theory to Practice: Breaking Down Three Barriers To A Total Portfolio Approach