Scott Stewart Portfolio Manager April 2016 Concentration, Correlation, Fragility, Volatility

Concentration

Positioning is extreme

Positioning is extreme – crowdedness of style

Fragility – the impact of herding

Markets are becoming more systematic

This leads to behavioural change

And some of the behaviours are very odd

Source: BarclayHedge Alternative Investment Database Systematic strategies are more prevalent

Which has led to valuation divergence

This can change the character of your investment

Increasing its risk

Liquidity & Vulnerability

Liquidity – depth, volume and volatility

Vulnerability – negative feedback loop

Volatility and Risk Management

Volatility – is it going away?

Source: “Third Generation Asset Allocation”, Brad Jones, Deutsche Bank, 2011 Diversification – 60/40 won’t help you

Source: “Third Generation Asset Allocation”, Brad Jones, Deutsche Bank, Data since 1984 or earliest available Dollar weight is not risk weight

What if I diversify into other asset classes?

Source: Artemis Capital Correlation varies through time

Volatility management should be part of a resilient portfolio Uncorrelated investment is fine but correlation is time-varying Systematic strategies can contribute to crowding/herding This can result in valuation extremes This is occurring when the market displays liquidity and structural issues The goal should be resilient portfolios as opposed to optimal portfolios The next generation should blur the line between asset allocation and risk management Good risk management should look for more certain negative correlation

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