Portfolio Managers Should Allocate Risk Capital to Beta Factors, Says Brian Singer

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By Rodney N. Sullivan, CFA

Brian Singer speaks at the 2011 Middle East Investment ConferenceAt the 10th Annual Research for the Practitioner Workshop preceding the 64th CFA Institute Annual Conference last month, Brian D. Singer, CFA, author of Investment Leadership and Portfolio Management and a former chair of the CFA Institute Board of Governors, delivered a presentation on portfolio management and risk.

Singer, who is currently chief investment officer of Singer Partners, LLC and previously served as head of Global Investment Solutions and Americas chief investment officer at UBS Global Asset Management, put forward a simple premise: that many portfolio managers are “unaware of the risks embedded in their portfolios.”

Singer’s point of view is that successful investing requires an understanding of risk factors and an allocation of risk capital to those factors which are compensated. At the same time, he argued, investors must eliminate uncompensated risk factors from their portfolios. Risk can be your friend, Singer said, but only if you are aware of what risks you face.

Because two-thirds of the variation in portfolio returns is driven by systematic risk factors (i.e., beta exposures), Singer said portfolio managers should shift their focus from a search for alpha driven by security selection toward an approach that allocates risk capital to beta factors. Examples of such beta exposures include inflation, credit risk, and illiquidity. Corresponding asset categories for risk budgeting purposes might be inflation-protected bonds, high-yield bonds, and real estate, respectively.

In short, returns originate in underlying economic drivers. Understanding this simple idea leads one to focus on harvesting systematic risk premia rather than pursuing the purported “free lunch” of unique alpha, Singer argued.

He summed it up simply, saying “a top down beta allocation framework is best.”

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2 Responses to Portfolio Managers Should Allocate Risk Capital to Beta Factors, Says Brian Singer

  1. heynnow says:

    Hi Rodney,

    Although very interesting, a fair amount of research has been done on this topic. I did a fair amount of research on this topic as well, including writing an article on optimal beta portfolios with a special application to risk parity portfolios. The fundamental problem in my opinion is optimizing technique used to screen for appropriate betas and their correlation and the cost of rebalancing the optimal weigts once the betas have been established. Furthermore what sort of robustness will correlations have moving through the next economic crisis? Please feel free to contact me if you wish to discuss this further.

    Kind Regards,

  2. Jacob Tadros says:

    See “Active Alpha” by Alan H. Dorsey (2007). His discussion of risk budgeting to beta factors sounds like what Mr. Singer is touching on.

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