The market environment during 2022 highlighted many uncertainties and the importance of “expecting the unexpected.” Here, we show how market conditions and correlations can evolve rapidly. As market dynamics continually change, strategies that can dynamically manage portfolio risk and diversification when market correlations increase will continue to be important when constructing a portfolio resilient to changing market conditions.
Correlations are not static and can significantly change the risk profile of a portfolio. Sharp changes can be missed by relying purely on longer-term correlations. For example, as shown below, in H1 2022 bonds were often positively correlated to equities when longer-term correlation measures would suggest they were negatively correlated. As correlations shift and markets do not necessarily behave independently of one another, material diversification can be difficult to achieve without active risk management and thoughtful portfolio construction. Incorporating a range of mathematical and statistical techniques to create reliable shorter-term estimates of correlation (and volatility) can help to manage risk under these circumstances.
Graham’s strategies use an active approach to diversification to strategically manage risk in a wide range of market conditions. The application of a disciplined risk management process is a cornerstone of the firm’s overall investment philosophy and a key consideration in the firm’s multi-strategy approach to portfolio construction.
Our quantitative strategies continuously monitor correlation and volatility across markets traded to maintain a balanced portfolio at all times. Graham’s proprietary quantitative portfolio construction process utilizes short-term cross correlations of markets and sectors to actively diversify exposure and control portfolio risk. We use a range of advanced statistical techniques that allow for stable estimates of covariance with a short lookback window, with the goal dynamic risk management vis-à-vis more accurate estimates of contemporary market volatility and correlation. This is particularly beneficial in markets where correlation and volatility are themselves prone to shorter-term changes.
Meanwhile, Graham’s discretionary portfolio managers trade tactically and have the ability to react dynamically to sharp market moves, with the goal of capturing long-term thematic opportunities while mitigating the risk of short-term market disruptors. Risk is reviewed in real-time in the context of prevailing market conditions. For example, in the lead up to Brexit, the range of potential market outcomes were vast and varied. Graham’s portfolio managers followed the market developments, shifting underlying themes or instruments traded to express their views. Graham’s Risk Committee, which meets daily to review a variety of quantitative and qualitative measures, analyzed various proprietary measures of Brexit preparedness, including a set of stress tests customized for a range of Brexit scenarios, as well as correlation analysis, PM liquidity surveys, position concentration, and VaR analysis, among other measures reviewed daily. Firm-mandated risk limits on discretionary strategies include volatility targets, strict drawdown limits, and customized stress test and position limits for specific strategies.
The unique synergies between Graham’s quantitative and discretionary businesses allow the firm to actively manage risk on a multi-dimensional scale across all our offerings. Daily Investment Committee meetings, real-time risk and performance monitoring, and a leading technology and operational infrastructure enable a powerful combination of human expertise and innovative, repeatable investment processes to help navigate changing market conditions.
Source of data: Graham Capital Management (“Graham”), unless otherwise stated
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It should not be assumed that investments that are described herein will be profitable. Nothing described herein is intended to imply that an investment in the fund is safe, conservative, risk free or risk averse. An investment in funds managed by Graham entails substantial risks and a prospective investor should carefully consider the summary of risk factors included in the Private Offering Memorandum entitled “Risk Factors” in determining whether an investment in the Fund is suitable. This investment does not consider the specific investment objective, financial situation or particular needs of any investor and an investment in the funds managed by Graham is not suitable for all investors. Prospective investors should not rely upon this document for tax, accounting or legal advice. Prospective investors should consult their own tax, legal accounting or other advisors about the issues discussed herein. Investors are also reminded that past performance should not be seen as an indication of future performance and that they might not get back the amount that they originally invested. The price of shares of the funds managed by Graham can go down as well as up and be affected by changes in rates of exchange. No recommendation is made positive or otherwise regarding individual securities mentioned herein.
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Tables, charts and commentary contained in this document have been prepared on a best efforts basis by Graham using sources it believes to be reliable although it does not guarantee the accuracy of the information on account of possible errors or omissions in the constituent data or calculations. No part of this document may be divulged to any other person, distributed, resold and/or reproduced without the prior written permission of Graham.