Part 1
About Venn
Venn is Two Sigma’s portfolio analytics platform used by asset owners, asset managers, and advisors. Venn applies Two Sigma’s expertise in research, data science, and technology to modernize the analytics experience for institutional investors, helping them embrace a quantitative approach to multi-asset portfolio risk and investment decision making. The tools available in Venn help investors perform factor-based risk analysis to inform manager due diligence, investment evaluation, and portfolio construction.
Two Sigma Investor Solutions, LP operates Venn – see here for important disclaimers and disclosures. Venn is for institutional investors only.
What is Venn?
Venn is a portfolio analytics platform for asset owners, asset managers, wealth managers, and advisors to quickly perform advanced analysis and better understand sources of risk and return across multiple asset classes.
What does Venn do?
The tools available in Venn help investors perform factor-based risk analysis to inform manager due diligence, investment evaluation, portfolio construction, and asset allocation.
What types of investors use Venn?
Venn is designed for professional investors managing multi-asset class portfolios (i.e., asset owners, asset managers, and advisors). Venn clients include pension funds, endowments, foundations, family offices, RIAs, wealth managers, fund of funds, and asset managers offering multi-asset solutions.
Why was Venn created? What is the connection to Two Sigma?
Two Sigma consistently heard from clients that existing risk tools failed to address the unique needs of allocators and managers of multi-asset portfolios.
Venn was created in response to such client demands for greater insight into their factor exposures as they approached asset allocation and outside manager evaluation decisions.
Before its public launch in November 2019, Venn was exclusively offered on an invite-only basis (2017-2019).
Now, Venn applies Two Sigma’s expertise in research, data science, and technology to modernize the analytics experience for institutional investors, helping them embrace a quantitative approach to multi-asset portfolio risk and investment decision making.
What types of factors does Venn analyze?
Venn analyzes portfolios and individual investments through the Two Sigma Factor Lens, which was constructed specifically for allocators managing multi-asset class portfolios.
The Two Sigma Factor Lens includes both Macro and Style Factors:
- Macro Factors are generally high-capacity, easy-to-access, asset-class based factors that we think cover most of the risk in investor portfolios (e.g., Equity or Interest Rate risk).
- Style Factors, on the other hand, are known to correspond to drivers of risk and return within various asset classes (e.g., Value or Momentum within individual stocks).
Part 2
Introduction to factors
What are factors?
Risk factors are discrete, describable sources of common or systematic risk and return across a diverse set of investments.
What are examples of common factors?
Macro factors like Equity, Interest Rates, and Credit are commonly found risk exposures in an institutional investor’s portfolio due to their high liquidity and capacity.
How does Venn classify factors?
Macro: High-capacity risk factors shown to correspond to the principal drivers of asset class returns. Macro risk factors are broadly known, widely accessible at a relatively low cost, and can explain most risk in long-biased, diversified institutional portfolios. Examples include Equity and Interest Rates.
Style: Lower-capacity risk factors shown to correspond to sizeable common risk drivers across individual securities but with lower correlations to asset class returns. Academic financial research has identified multiple style factors that appear to have long-term return premia resulting from investor behavioral biases or risk aversion to certain asset characteristics.[1] Style factors require skill to capture and manage but have relatively higher capacity and lower investment costs than alpha. Examples include Value and Momentum.
Residual: Idiosyncratic sources of risk (i.e., uncorrelated to other known factors) that are limited in capacity and have historically commanded higher fees. These risks generally appear as “residual” in a returns-based statistical factor analysis.
What is a “risk premium”?
Factors with strong empirical evidence and/or fundamental justification for a long-term return premium are considered to have a “risk premium,” which may reward investors for holding exposure to that risk factor over time. Not all identifiable risk factors carry a corresponding risk premium.
Why can “risk premia” exist?
A risk premium may compensate investors for bearing certain risks such as undiversifiable market risk, mandate constraints, operational complexity, or behavioral biases like risk/loss aversion, herding mentality, or recency bias.
What are examples of factors with a historical risk premium?
The Equity factor, which represents exposure to fundamental risks such as macroeconomic growth and corporate profitability, is an example of a macro factor that has historically delivered a positive long-term return in excess of the risk-free rate. The Momentum factor, which represents exposure to investor behavioral biases such as initial under-reaction to fundamental news about companies, is an example of a style factor that has historically delivered a positive long-term return in excess of the risk-free rate.
What is a risk lens?
A risk lens represents a complementary set of factors selected for a particular analytical task, such as identifying risk and return drivers in a diversified institutional portfolio or when evaluating an individual investment.
How can a risk lens be used?
A thoughtfully chosen and constructed risk lens can offer a unified framework and measurement tool to enhance allocation decisions in a portfolio. Top-down analysis can help allocators better understand the total magnitude of the largest risk drivers in a portfolio by estimating the total factor risk contributions across the portfolio. This allows for pro forma and optimization analyses of portfolio changes, which can better align overall risk exposures with an allocator’s forward-looking views on factor returns.
In addition, a factor lens can help bottom-up manager selection by estimating the risk factor overlap of adding new holdings to an existing portfolio and helping separate idiosyncratic risk of a manager from identified macro or style factor risk.
How can a risk factor lens help with portfolio construction?
A risk factor lens composed of orthogonal risk factors can estimate the contribution of independent, uncorrelated risk and return drivers in a portfolio. This can provide a more accurate measure of diversification than an asset-class-based analysis.
How does risk factor diversification compare to traditional asset class diversification?
Part 3
Factor Analysis on Venn
The Two Sigma Factor Lens
*Additional descriptions are included below
How does Venn use factors?
Venn uses factors to help institutional investors better understand the risk composition of their portfolios, strategies, and investments. Exposures to factors are calculated using a sequence of regressions on returns.
How can Venn help allocators?
We believe Venn can help allocators learn more about the potential factor exposure of their portfolios (absolute or relative to benchmark) based on the return histories of their current portfolio holdings. Venn displays the estimated exposures and contribution to risk and return for each factor identified in any return stream.
We also believe Venn can assist in allocation decisions by analyzing and estimating the historical marginal impact of adding, eliminating or reweighting an investment in your portfolio.
What types of portfolios is the Two Sigma Factor Lens designed to analyze?
The Two Sigma Factor Lens is designed to aid in the analysis of institutional investor portfolios whose investments span multiple asset classes.
How does Venn calculate factor exposures?
Venn uses a two-step regression process to calculate factor exposures:
Step 1: First, the full factor lens is run through a Lasso regression to balance model fit with the number of factors and the R-squared. Factors with 0 beta coefficients after the Lasso regression are considered irrelevant and are excluded from the analysis. This step can improve the interpretation of risk drivers and enhance the accuracy of the analysis by discarding the noise from irrelevant factors, while also reducing potential overfitting or false positives. Furthermore, if the R-squared based on factors selected is negative, we will exclude all factors from the analysis.
Step 2: The second step is the ordinary least squares (OLS) regression, which applies the selected factors as independent variables against each return stream. The final Betas and t-stats from this step are displayed in Venn. For t-stats, a value greater or less than +/-1.96 is considered statistically significant. Within the selected factors from step 1, Venn will highlight those that are both statistically significant and explain more than 1% of risk.
Please note that for daily data, Venn runs the regressions on rolling 5-day average returns for both factor returns and portfolio/fund returns to minimize impact of market asynchronicity. Newey-West correction is applied to the t-stat to correct for the heteroskedasticity and autocorrelation in the time series data.
Are there other factor lenses on Venn?
No, the only factor lens on Venn is the Two Sigma Factor Lens.
Part 4
More Information
Who provides the Two Sigma Factor Lens?
We license the Two Sigma Factor Lens from Two Sigma Investments, LP (“TSI”), an affiliate of ours. Please note that TSI and other affiliates of ours use, construct, and maintain different factors or methodologies from those we use on Venn, including when making investment decisions on behalf of or when trading for purposes of their investable products.
Will the Two Sigma Factor Lens change?
Yes. We anticipate a growing and changing factor lens as research continues to update existing risk factors and address additional risk factors. Changes to the factor lens may affect prior analyses on Venn. The lens may also change under the terms of our license with TSI.
Our Form ADV, publicly available on Venn, also contains important information about the use of factors on Venn as well as our licensing relationship with TSI.
