Given the recent market movements associated with the Covid-19 pandemic, many of you may now be working on rebalancing your portfolio(s) to get back to your target weights. Once you’ve updated your managers’ latest returns and allocations, inputted your target factor exposures and forward-looking capital market assumptions, Venn Pro can help you plan for capital reallocations. Let’s walk through these workflows together.
- Understand recent performance and factor exposures
Let’s start by establishing a base case. After uploading your managers’ latest returns and updating the latest AUMs associated with each investment, use Venn to calculate historical pro forma portfolio performance, risk metrics, correlations and factor analysis. Double-click metrics to break down portfolio risk, return and factor exposures into their investment-level contributions.
As a reminder, you can toggle on “Relative to Benchmark” to see the relative statistics like Excess Return, Tracking Error and Active Factor positioning.
- Input your capital market assumptions to create customized long-term factor forecasts
Now that you have a sense of your historical performance and current factor exposures, let’s dive into those Forecast metrics and update your forward-looking views.
First, to get some historical perspective, you may want to open up a second tab and pull up “Factor Insights” to see how each factor has performed throughout history. In particular, take a look at the Performance Characteristics summary table at the bottom. You can also view the factor performance over the available history of your portfolio by changing the Analysis Period on the top right. If using the pre-loaded Demo Portfolio, as an example, we might want to see the factor returns since that portfolio’s inception, starting in December 2011.Now let’s go back to our Venn Tearsheet and click on the “long-term forecasts” link at the top of the Performance Summary chart, and enter your capital market assumptions (or CMAs) for the next ~3+ years.
In the above example, we are assuming that global equities, as proxied by the MSCI World Index, will return 5% over the next ~3+ years on an annualized basis, whereas commodities, as proxied by the S&P Goldman Sachs Commodity Index, will return -4% annually over the same time period. Lastly, we are assuming that emerging markets, as proxied by the MSCI Emerging Markets index, will return 3% annually, underperforming their developed market counterparts by 2%.1
Venn will then translate these CMAs into factor forecasts.
Given these sample long-term assumptions, this portfolio is expected to have a positive annualized return going forward of 4.7%, which would be lower than the historical return of 5.3%, and a higher volatility of 9.6%, versus the historical 8.0%.Why is that? At a high level, the Forecast return is lower than the Historical because the translated forward-looking forecasts for the factors that this portfolio has exposures to are less than they have been historically. Let’s dive deeper into this concept. The portfolio's largest current factor exposure (over the past three years) is Equity, with a beta of 0.54. Over the full life of the portfolio (historically), the Equity factor returned 8.1%. However, after we entered and translated our CMAs, the Forecasted (forward-looking) return for that factor is only 4.2%. It is also important to note, given this is an additional input in the Forecast metrics and optimization more broadly, that the Residual Contribution to Return of the portfolio has been declining. It was -0.6% annualized over the entire historical period but has been -1.2% over the most recent 3 years, further contributing to the lower Forecast return.
- View your Venn optimized allocation
Now that you’ve added in your revised CMAs, let’s optimize your portfolio to see the suggested allocation changes that can help you rebalance to your investment targets.
In the below scenario, the main objective is to achieve the highest possible annualized return, while not exceeding 10% volatility. After clicking “Constraints,” you can increase the “Max Allocation” dollar amount to allow more capital to a particular asset class or investment - if, for example, it is currently below your target allocation due to recent underperformance. You can also lock an allocation to reflect the illiquidity of the investment.Alternatively, you can use the Optimization tool to target specific factor exposures. Click on the “Set Factor Exposures” tab and dial the factor “Exposures” (betas) up or down, if you’d like to increase or decrease your portfolio’s exposure, respectively.
Once you’re all set, click “See Results.”
As per the above results, the Optimized portfolio has a higher estimated forecast return of 5.9% versus the Current portfolio’s 4.7%. You can also toggle on “Trades” to easily see the suggested allocation changes to move towards this Optimized portfolio.
- Evaluate various asset allocations for your portfolio
Now let’s switch that comparison column from the “Optimized” view to the “Last Saved” view. By adjusting the investments’ allocations, you can iterate and test different tactical asset allocations to see both the historical and forward-looking impacts to your portfolio’s risk, return and factor exposures.
In the below example, the allocations in purple have been altered. Compare the metrics of the “Current” test portfolio to the “Last Saved” portfolio to see the results of each version. Also, view your test portfolio’s factor exposures to confirm they better align with your targets.
- Organize and revisit prospective managers to see if they can fill any gaps
While viewing Venn’s library, be sure to “tag” specific managers and create folders to organize them. For example, create a tag for prospective “Pipeline” managers and another for those current managers on your “Watch list.”
Now that we know what the optimal portfolio allocation looks like, let’s see if increasing the weights to existing investments, or adding in a recently tagged prospective manager in your “Pipeline,” would bring you closer to your desired return objectives and factor exposures. To do this, either type in the revised allocation next to a current investment, or click the ellipsis (three dots) to add in a new investment—then compare the results of the two portfolios.
Hopefully many of these exercises will come in handy throughout the year. Don’t forget that you can export the charts and tables as images and, in certain cases, export the analysis output data to Excel. You can also click “Share” at the top of analysis pages to easily print a report or share the link to the analysis with your colleagues. Let us know how it goes and if there are other workflows we can explain in further detail.
1 Note: These assumptions do not represent Two Sigma's view of the future performance of these indices. We have chosen the assumptions arbitrarily for the purposes of providing you with an example for instructional purposes.
2 Available in certain jurisdictions.
This article is not an endorsement by Two Sigma Investor Solutions, LP or any of its affiliates (collectively, “Two Sigma”) of the topics discussed. The views expressed above reflect those of the authors and are not necessarily the views of Two Sigma. This article (i) is only for informational and educational purposes, (ii) is not intended to provide, and should not be relied upon, for investment, accounting, legal or tax advice, and (iii) is not a recommendation as to any portfolio, allocation, strategy or investment. This article is not an offer to sell or the solicitation of an offer to buy any securities or other instruments. This article is current as of the date of issuance (or any earlier date as referenced herein) and is subject to change without notice. The analytics or other services available on Venn change frequently and the content of this article should be expected to become outdated and less accurate over time. Two Sigma has no obligation to update the article nor does Two Sigma make any express or implied warranties or representations as to its completeness or accuracy. This material uses some trademarks owned by entities other than Two Sigma purely for identification and comment as fair nominative use. That use does not imply any association with or endorsement of the other company by Two Sigma, or vice versa. Click here for other important disclaimers and disclosures.