Five Levers for Reducing Equity Risk

Five Levers for Reducing Equity Risk

Controlling exposure to equity risk is a key priority for investors in 2019. This paper outlines five tools for improving diversification and/or resilience to equity downturns.

Reducing Equity Risk


Understanding risk exposures. The term "well-diversified" is over-used and often lazily applied. While high quality risk analytics can help to provide clarity, investors and stakeholders should distinguish between two key objectives: diversification to improve long-term risk-adjusted returns and diversification to improve portfolio resilience. These do not go hand in hand.

Five levers for improving diversification, resilience or both. This paper examines: illiquid alternatives, liquid alternatives, overlays, changing the composition of the equity portfolio and moving towards fixed income. In each case it is key to consider current market realities, not just historically-generated models.

Equity risk drift. In some of these areas, most notably private markets, we observe a notable trend towards higher underlying equity risk exposure within portfolios. This can be visible, such as a move from "core" to "value-add," but can also be opaque given current style drift within strategies under the same name. Monitoring can be difficult: managers are not incentivised to understand their equity risk factor exposure and risk analytics are challenging in private market investments.

Reducing Equity Risk


Controlling equity risk exposure us a key priority for bfinance clients in 2019. A turbo-charged - and largely policy-driven - stock market surge in the first half of the year has reinforced the issue.

There is no silver bullet for improving portfolio diversification or resilience to equity market downturns, especially where stakeholders cannot accept a reduction in real return expectations.

It is therefore useful to consider approaches that are multi-faceted and, notwithstanding the long-term horizon, sensitive to current market or industry realities. Stakeholders should evaluate their true priorities and consider which levers are more or less attractive today from an implementation perspective.

Important Notices

This commentary is for institutional investors classified as Professional Clients as per FCA handbook rules COBS 3.5R. It does not constitute investment research, a financial promotion or a recommendation of any instrument, strategy or provider. The accuracy of information obtained from third parties has not been independently verified. Opinions not guarantees: the findings and opinions expressed herein are the intellectual property of bfinance and are subject to change; they are not intended to convey any guarantees as to the future performance of the investment products, asset classes, or capital markets discussed. The value of investments can go down as well as up.