Portfolio design

Building resilience with macro factors

Andrew Ang, PhD| Katelyn Gallagher| Kristin Fergis| Philip Hodges, PhD |Sep 18, 2019

Many portfolios that appear well-diversified across asset classes may not be sufficiently diversified across risk exposures. We think it’s possible to build more resilient portfolios by allocating risk to macro factors rather than allocating capital to asset classes.

Portfolio resilience has long been a goal of institutional investors. Indeed, it is the desire for portfolios that can perform well in a variety of market environments that led many investors to diversify their holdings across asset classes by embracing strategies such as the traditional 60/40 allocation. But by our estimates, a traditional 60/40 portfolio derives more than 90% of its risk from equities1.

For this and other reasons, many investors look to factor-based investing as a way to potentially increase diversification and bolster resilience. While traditional approaches typically capture growth as markets rise due to concentrated equity risk, they often lack resilience as markets fall—when investors need it most. By deliberately allocating to macro factors instead of to asset classes, we can seek growth when markets are rising as well as improved downside mitigation in more challenged environments.

Two simple rules

Our approach to building a truly diversified and resilient multi-asset portfolio is grounded in two simple rules.

  1.  We allocate risk instead of capital. Allocating capital, as in traditional asset allocations, may ignore the inherent relationships between asset classes and result in unintended risk concentrations.
  2. We allocate to factors, instead of to asset classes. We’ve found that six macroeconomic factors—economic growth, real rates, inflation, credit, emerging markets and liquidity—explain more than 90% of the returns across asset classes2. By explicitly allocating to these factors, we can avoid concentration in any single factor.

    Macro mapping

    Macro factor exposures of asset classes

Macro mapping

Source: Aladdin Factor Workbench, as of 31 July 2019. The asset classes shown in the chart are represented by the following indices: Inflation-Linked Bonds: Barclays US Govt Inflation-Linked Bond Index; Nominal Bonds: Barclays Govt Index; Corporate Bonds: Barclays Global Aggregate Bond Index; Equities: MSCI ACWI; Real Estate: BlackRock Proxy; Private Equity: BlackRock Proxy; Infrastructure Equity: BlackRock Proxy.

Three portfolios

To examine the potential benefits of the factor-based approach we looked at the performance of three hypothetical portfolios3 over 15 years, from July 2004-July 2019.

  1. A traditional multi-asset portfolio that allocates capital across asset classes.
  2. A risk parity portfolio that allocates risk across asset classes.
  3. A factor-based portfolio that allocates risk across macro factors.

Four key takeaways

  1. Compared to the other portfolios, the factor-based portfolio provided incremental monthly returns over the course of a full economic cycle, on average.
  2. The factor-based portfolio experienced a shallower drawdown during the global financial crisis.
  3. The factor-based portfolio delivered higher returns and a higher Sharpe ratio.
  4. Allocating even a small percentage of a total portfolio to a macro-factor strategy can provide meaningful benefits.
Andrew Ang
Managing Director, Factor-Based Strategies
Andrew Ang, PhD, Managing Director, coordinates BlackRock's efforts in factor investing.
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Philip Hodges, PhD
Managing Director, Head of Research, Factor-Based Strategies
Philip Hodges, PhD, Managing Director, is Head of Research for BlackRock's Factor-Based Strategies Group.
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Katelyn Gallagher
Director, Factor-Based Strategies
Katelyn Gallagher, Director, is a senior investment strategist in BlackRock's Factor-Based Strategies Group.
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Kristin Fergis, CFA
Vice President, Factor-Based Strategies
Kristin Fergis, CFA, Vice President, is a member of the Factor Based Strategies team within BlackRock Multi-Asset Strategies Group. As an investment strategist, her role ...
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