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The Landscape of Risk

risk management

This article is sponsored by S&P Dow Jones Indices.

Risk is a complicated thing, and S&P Dow Jones Indices’ experience supporting the VIX® series of volatility measures, its continued work in the arena of low-volatility indices and its conversations with clients regarding risk reduction techniques continue to reveal new things about the way markets and investors can react to – and even control – volatility.

But market volatility is not all there is to it. Which is why S&PDJI recently inaugurated commentary on equity market “dispersion”, a market-wide measure of security-specific risk that can be useful in identifying markets and time periods where there is greater opportunity to add value through security selection.

That risk can be indistinguishable from opportunity is a concept as old as the hills, but it is one that is rarely studied. It turns out that including dispersion as well as volatility in the analysis can have surprising results, particularly when applied to common equity factors such as value, or momentum. SPDJI is pleased to include its latest thinking on the topic in “The Landscape of Risk]”.

Research Summary
J.P. Morgan famously remarked, when asked what the stock market would do, that “it will fluctuate.” It was a safe prediction. No matter how we regulate or manage our markets, volatility frequently roiles them. From a classical point of view, high volatility presents opportunities – the prime example being the predictable increases in both risk and return that result from the application of leverage. Thus by implication in the typical legal disclaimer, an increased opportunity for return is associated with increased risk.

Yet periods accompanying extreme fluctuations in the equity market are more often than not associated with losses. In Section 1, “The Landscape of Risk” examines the negative correlations that emerge between market prices and volatilities of the U.S. equity market. Two themes emerge – first, that market behaviour is fundamentally different during periods of high volatility, and second, that opportunities, if they are present, might be comprehended as simply the chance to purchase equities at a discount.

In Sections 2 and 3, the paper examines the structural composition of market risk via the relationship between the volatilities of individual securities and market benchmarks, and relate each to the other with approximating equations. These equations describe a three-dimensional surface, a “landscape of risk,” which is compared to historical market behavior in Section 4.

Not all crises are the same. Although each major pullback in U.S. equities during the past decade has been characterized by unusually high correlations, the bear markets of the early 2000s were instead accompanied by a large degree of independence among the stocks of different sectors. The results of Section 4 describe the role of correlations in crisis periods and describe the potential evolutions of volatility and stock-to-stock correlation that might accompany the next one.

A second goal of this paper is framed by the notion of seeking opportunity in crisis. This theme emerges in Section 1 in the context of market performance, and in Section 2 is a discussion of the subtleties that arise in applying the same concepts to single securities. In Section 3, the paper introduces the concept of dispersion in order to address these subtleties. In Section 5, the paper attempts to attribute the historical relative performance of equal weight, growth, value, and momentum strategies to changes in U.S. equity dispersion. Finally, in Section 6, the current environment is described.

S&P Dow Jones Indices’ “The Landscape of Risk” white paper can be downloaded here. The Landscape of Risk.

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Transforming Saudi Arabia’s Capital Markets

This article is sponsored by State Street.


– Vision 2030 and the Aramco privatization mark a decisive point to advance Saudi Arabia’s financial sector — a critical ingredient to the country’s economic transformation

– Saudi’s “Financial Triad” remains partially incomplete with a sound banking system and a rapidly emerging equity market, but an immature bond market.

– The privatization of Saudi state assets (including Aramco) could deliver a boost to the depth and sophistication of the Saudi equity market and — if cleverly designed— have positive spillover effects into other areas of finance and policy.

– The timing is ideal to launch an accompanying systematic drive to build local currency bond markets, which is a prerequisite for achieving the broader economic goals of Vision 2030.

Saudi Arabia’s Vision 2030 is remarkable in its aspiration to engineer far-reaching economic transformation. As a global asset manager, we note that one of the three pillars of this vision sets out the aim to make the country a “global investment powerhouse.” 1

While Saudi Arabia has a strong legacy as a sovereign investor in foreign markets, this ambition also requires its local financial system to deepen across all sectors. Strong capital markets work together with a banking system to channel investment and ensure efficient capital allocation across the economy. In the absence of such channels, many worthwhile business ventures never take place, capital is misallocated and underutilized, and economic growth remains below its potential.

To read the full study please click here.

1 Foreword to Vision 2030,

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Sovereign Wealth Funds as a Driver of African Development

This article is sponsored by Quantum Global.

Sovereign wealth funds (SWFs) are becoming important sources of development in many countries. African SWFs have been growing in recent years, as many countries joined the international trend in establishing SWFs, while many others are preparing to join. Growth of SWFs has been driven by rising commodity prices until 2014 and improving economic growth rates. At the same time, Africa continues to face a number of development challenges, raising the question of whether SWFs can play a role in fostering economic development on the continent. This paper analyses the dynamics and role of SWFs in promoting development in Africa. The paper notes that SWFs can play a more active role in Africa’s development by bridging the infrastructure funding gap, supporting industrial development and economic diversification, reducing macroeconomic volatility and enhancing intergenerational equity. For SWFs to be effective in delivering their mandates and supporting economic development, they need to have clear goals and objectives, improve their governance and transparency frameworks, improve their risk management frameworks and embrace the Santiago Principles. African governments need to develop more attractive frameworks and climates for SWFs to invest in the continent, especially in sectors that contribute more directly to addressing Africa’s development needs.

To read the full study please click here.

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Collateral: The New Performance Driver

This article is sponsored by BNY Mellon.


In 2017, the global buy-side community faces considerable liquidity and funding pressures, stemming from market and regulatory reforms that are causing disruption. As a result, access to high-quality collateral, funding and liquidity is not only a pressing concern but has emerged as the essential new performance driver for the buy-side.

This disruption is the result of two opposing forces. Stringent regulatory requirements are forcing market participants to seek collateral — generally of high quality — in order to secure trading exposures. At the same time, the sell-side — or dealer-sponsored financial plumbing used to supply liquidity and collateral to the market — is experiencing challenges due to Basel III capital and liquidity constraints.

A major concern among multiple buy-side firms is that the next market-stress event will occur not because of a lack of collateral in the financial system but rather due to the inaccessibility of this collateral.¹ This scenario is forcing firms to reevaluate their collateralized trading portfolios, recalibrate asset allocation strategies and in some cases review the investment products offered to end clients.

This paper presents the findings from BNY Mellon–PwC outreach to senior buy-side executives from over 120 global firms conducted during the first quarter of 2017. It provides insights on demand-supply imbalances that are being experienced by buyside firms and the possible solutions they are exploring in response to fears that ready access to liquidity and high-quality collateral may become scarce in the years ahead.

The picture that emerged from these discussions was one of a buy-side community both grappling to adjust to its new collateralized trading obligations as well as striving to secure access to sustainable sources of funding and liquidity.

To read the full study please click here.

1. Collateral can be inaccessible due to decreasing velocity of collateral, which indicates how much, on average, a single dollar of collateral is reused over a period of time. This is analogous to the concept of “velocity of money.”

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