Axioma Risk Monitor
AXIOMA RISK MONITOR
Equity edition

Russell Recon Leads to Temporary Jump in Risk; Info Tech Sees a Substantial Increase in Weight and Index Risk Contribution; Growth Factor Comes to Life in Most Regions

 

HIGHLIGHTS FOR THE WEEK ENDED JULY 3

 
 
 

Russell Recon Leads to Temporary Jump in Risk

 

Last week’s reconstitution of the Russell 2000 index led to a brief increase in the index’s short-horizon fundamental forecast, according to Axioma’s US Small Cap model. In contrast, there was almost no change in the comparable Russell 1000 risk estimate. The increase in the Russell 2000—which was related to the rebalance—seems to have been short-lived, however, as the risk forecast began to back down the next day. The decomposition of the change in risk at the stock level for the week ended July 3 attributed most of the change to a sudden increase in correlation. The drop in correlation is not surprising, as many investors trade into the new index in advance of the official rebalance date, thereby causing stocks to move together more than they otherwise might. This also suggests the jump is temporary (all other things being equal), as prices of the newly minted Russell 2000 names settle back down to reflecting company characteristics.

See graph and table from US Small Cap Risk Monitor as of 3 July, 2019:




 

Info Tech Sees a Substantial Increase in Weight and Index Risk Contribution

 

The index weight and contribution to risk of most sectors in the FTSE Developed index have remained remarkably steady over the past six months, even as benchmark risk has dropped by more than a third. The major exception is Information Technology, which saw an increase in both weight and, proportionally, risk contribution. The increases in the Global Developed index mirror results in the Russell 1000 and FTSE Japan, but not most other regions. In the Russell 2000, both weight and risk contribution fell over this period. Asia ex-Japan saw an increase in percent of index risk, while Tech’s weight remained steady, and other places saw little change in either. The heavy weight of Technology in the US (more than 20% of the Russell 1000 and considerably more than that of another other sector), along with its relative riskiness, may explain why the US remains one of the riskiest of the markets we track closely.

See graph from Global Developed Markets Risk Monitor as of 3 July, 2019:

 

 

Growth Factor Comes to Life in Most Regions

 

The Growth factor has had a good few months in a number of regions. While it does not have the highest magnitude of return among the multitude of factors across our regional and single-country models, it is one of the few to have experienced unusually high risk-adjusted returns in Europe, Emerging Markets, and in the Worldwide model. Its positive return in each of those regions was more than two standard deviations above its (negative) long-term average. It has also been strong in the US and Asia Pacific, although not enough to fall outside the “normal” range of returns. It only produced negative returns in Canada, Australia and Japan. One potential explanation for the factor’s strength is that growth is slowing down in many parts of the world. When economic growth is strong, and everything is growing, this factor may not sort out winners from losers. But when growth slows, those stocks that continue to exhibit growth become relatively more attractive as investors look for where they can get growth into their portfolios.

Note: The chart below does not appear in the risk monitors, which are produced by region, but is available on request. In the regional monitors Growth’s return is shown relative to other factors for that regional model.


 

 

 
 
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Factor Performance Continued to Fall Short in Q2—and Constraints Only Made Things Worse

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The Truth About Fixed Income Factors

Traditional fixed income models are not well placed to live up to more advanced demands. So what to do?


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Note: The recent decision by FTSE to add China A Stock Connect stocks to its indices had little effect on their risk, since the A shares were added initially with a small (25%) weight. However, the addition of so many names has had an impact on the average daily trading volume which accounts for the new names at full weight. That is the source of the huge jump in chart 25 in some of the risk monitors.

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