Sometimes taking action is harder than it seems. This is especially true for capital allocators as portfolio analysis often incorporates trial and error, with seemingly infinite ways to interpret the results. This opens the door to analysis paralysis, which can cause inefficiency, confusion, and potentially inaction.
To help investors translate their portfolio analytics into tangible asset allocation decisions, one of our goals in designing Venn by Two Sigma is for it to be actionable.
What does actionability mean to us? We believe:
- Explaining risk and return using only a handful of factors leads to more intuitive and important asset allocation insights.
- Allocators should be able to identify sources of risk and return whether at the total portfolio, sleeve, manager, or asset level.
- Understanding changes in asset allocation should come with as few barriers as possible, encouraging thorough analysis and promoting decision making.
1) A Less-Is-More Approach to Factor Analysis
The first point refers to one of our other four pillars of Venn: Parsimonious. We encourage readers to click on the link, but in short, in a world with seemingly infinite factors with overlapping risks, we use just 18 or fewer factors for portfolio analytics. We believe this “less-is-more” approach improves the interpretability of results and helps allocators go from insights to decision making.
2) Identifying Sources of Risk and Return Are Critical
Granularity can be a powerful ally in investment analysis, but also a daunting foe. For example, it may be counterproductive to identify the 10 different fundamentals that are driving value exposure in your overall portfolio, but it is likely very productive to understand which of your 10 individual managers are.
When Venn decomposes exposure, risk, and return, you are able to source not only which sleeve it’s coming from, but also how much is being driven by each individual manager or asset. This is true when sourcing not only familiar statistics such as standard deviation and maximum drawdown, but also analytics from our Two Sigma Factor Lens, which include Macro, Secondary Macro, Macro Style, and Equity Style Factors.
For example, using Venn's "Demo Portfolio” below, we show how we can source value exposure across individual managers and even separate sleeves of the portfolio. For an allocator who wants to add or decrease their value exposure, this may identify the most impactful places in your portfolio to achieve that goal. Venn also views portfolios holistically, meaning it can help allocators identify their sources of value exposure, including sleeves or managers that may not be directly associated with value allocations.
Source: Venn by Two Sigma. For illustration purposes only
3) Quickly See the Effects of Asset Allocation Changes
After decomposing and understanding sources of portfolio risk and return, a natural next step is to begin adjusting your portfolio to reflect your investment thesis or mandate. This can sometimes be a mix of art and science, adjusting allocations and then seeing the effects.
For example: “What happens if I add 2% from one of my fixed income managers to one of my equity managers?”, “What if it's 5% instead?” Rather than needing to start from the beginning each time, Venn is designed to recalculate risk, return, and factor data on the fly, making it easy to understand the impact of your asset allocation decisions quickly. You can also compare your analysis side by side with previous versions, allowing for easy visibility into what’s changed.
Source: Venn by Two Sigma. For illustration purposes only
Retrieving output for specific parts of your portfolio is also easy, reframing your analysis to the layer of insight you seek. For example, below we isolate and conduct analysis on the alternative sleeve.
Source: Venn by Two Sigma. For illustration purposes only
Venn’s analysis, at any level, can also be easily conducted relative to a benchmark, highlighting active positioning.
Source: Venn by Two Sigma. For illustration purposes only
We believe this type of speed, flexibility, and transparency in investment analysis ultimately encourages thoroughness and promotes decision making.
Using Technology to Drive Portfolio Insights
While it is true that sometimes the best asset allocation decision may be to do nothing, “allocate” is ultimately a verb. As a result, we believe Venn analysis should be meaningful and enable actionable asset allocation insights. This is why we limit the number of factors we use, enable sourcing of risk down to the individual asset, and make it easy to conduct on-the-fly calculations.
Alongside our actionable pillar, we have written three other pieces discussing Venn’s fundamental pillars, which together comprise Venn.
Venn’s Four Fundamental Pillars:
- Holistic, by capturing the large majority of cross-sectional and time-series risks for typical institutional portfolios.
- Parsimonious, by using as few factors as possible.
- Orthogonal, with each risk factor capturing a statistically uncorrelated risk across assets.
- Actionable, such that desired changes to factor exposure can be readily translated into asset allocation changes.
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. Any statements regarding planned or future development efforts for our existing or new products or services are not intended to be a promise or guarantee of future availability of products, services, or features. Such statements merely reflect our current plans. They are not intended to indicate when or how particular features will be offered or at what price. These planned or future development efforts may change without notice. 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. See the end of the document for other important disclaimers and disclosures. Click here for other important disclaimers and disclosures.
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