CACEIS NEWS 37

produCts AND services New frontiers in risk assessment and performance reporting In this new research, EDHEC-Risk Institute is introducing an improved measure to allow institutional investors better assess portfolio diversification and risk-adjusted performance.

2 caceis news - No. 37 - March 2014

I n a new publication entitled “Improved Risk Reporting with Factor-Based Diver- sification Measures,” drawn from the ED- HEC-Risk Institute research chair supported by CACEIS on “New Frontiers in Risk As- sessment and Performance Reporting,” ED- HEC-Risk Institute encourages institutional investors to look carefully at the effectiveness of their portfolio diversification. Before the financial crisis, pension funds were insufficiently diversified, with concen- tration in a small number of asset categories. Since the crisis of 2007, there has been a gen- uine trend towards investment in new asset classes and categories in order to diversify, but that does not mean that the diversifica- tion is effective. The study examined the 1,000 largest US pension funds as of 30 September 2002, 30 September 2007 and 30 September 2012. The research introduces new diversification measures based on the concept of risk allo- cation rather than the concept of asset allo- cation. The authors’ aim was to measure the Why is CACEIS sponsoring the EDHEC- Risk Institute’s research chair on “New Frontiers in Risk Assessment and Performance Reporting”? The sponsorship of this new three-year chair, demonstrates CACEIS’s desire to play a central role in the analysis of key developments in the industry. Gaining a fuller understanding of the risk factors to which asset management companies are exposed, enables the Group to enhance its client support by offering optimal servicing solutions. What is the main aim of this three-year chair and what are the key issues it raises? The chair, which is designed to aid institutional investors and asset managers, seeks to explore new concepts in risk assessment and performance reporting as well as new ways of applying those concepts that are currently popular in the investment industry. The chair will focus on two principal issues: ▷ The first is the impact on institutional investors’ and asset managers’ reporting of the increasing shift in ‘conceptual paradigm’ from an asset allocation policy to a risk allocation policy, which is leading to a focus on categories of risk rather than of assets. ▷ The second issue covers advances in extreme risk measurement and reporting for funds and institutional investments, with proposals for new risk indicators that enable improved measurement and management of investment risks.

correspondence between the appearance of diversification (the effective number of class- es or constituents, or ENC) and the reality of diversification (the effective number of bets, or ENB), which measures the actual number of independent risky bets taken by institu- tional investors. Risk-adjusted performance is measured more effectively by using ENB. Increasing the number of asset classes or categories without taking the inter-relations between their risks into account does not provide any real gain in terms, first, of diver- sification, and then of performance. This new research chair should lead to im- proved risk reporting, by shifting from asset allocation to risk factor allocation; enhanced risk measurement for diversified equity port- folios; and better geographic segmentation for equity investing. This work will result in another step forward for CACEIS as its business is at the crossroads of the needs of its clients and the services a major Asset Servicing player should be able to offer the asset management industry ■

The conference includes two major events that will allow professionals to review major industry challenges, explore state- of-the art investment techniques and benchmark practices to research advances. ▷ On the first day, the Indexation and Passive Investment Conference will explore smart beta allocation, new index and benchmark offerings in the equity and fixed income universes and risk management. The conference will also be the occasion to discover new research on portfolio construction and efficient risk diversification. ▷ On the second day, the Global Institutional Investment Conference will present the results of EDHEC-Risk research on themes of great interest to institutional investors. At the plenary session chaired by Joe Saliba , Deputy Chief Executive Officer, CACEIS, Lionel Martellini , Professor of Finance, EDHEC Business School, and Scientific Director, EDHEC-Risk Institute will comment the results of the research drawn from the chair supported by CACEIS “New Frontiers in Risk Assessment and Performance Reporting.” Monetary Authority of Singapore (MAS); the City of London in the United Kingdom; Nice and Paris in France; and New York in the United States. The philosophy of the institute is to validate its work by publication in prestigious academic journals, but also to make it available to professionals and to participate in industry debate through its Position Papers, published studies and conferences. Each year, EDHEC-Risk organises three conferences for professionals in order to present the results of its research, one in London (EDHEC-Risk Days Europe), one in Singapore (EDHEC-Risk Days Asia), and one in New York (EDHEC-Risk Days North America) attracting more than 2,500 professional delegates. About EDHEC-Risk Institute EDHEC-Risk Institute is located at campuses in Singapore, which was established at the invitation of the

A copy of “Improved Risk Reporting with Factor-Based Diversification Measures” is available on www.caceis.com

Interview with Philippe Bourgues, Head of Operational Line – Front Office Solutions, CACEIS

How could EDHEC-Risk Institute’s proposed indicators, which enable improved portfolio risk measurement and diversification, be included in risk and performance reports generated by CACEIS, and which clients stand to benefit? According to the EDHEC-Risk Institute’s paper, the two formal measures of portfolio diversification - the Effective Number of Constituents and the Effective Number of Bets - afford asset managers a ‘predictive view’. In addition to the Value-at-Risk and tracking error, the EDHEC-Risk Institute identifies other forward-looking (ex-ante) indicators which allow asset managers to understand potential risks to which their portfolios may be exposed. For example, an assessment can be made as to whether there is a correlation between a portfolio’s degree of risk diversification (using a suitable measurement), and its performance through various market conditions. This can be done by analysing correlated constituents to understand how well or poorly diversified a portfolio is. CACEIS’s massive investment data repository, when combined with the EDHEC-Risk Institute’s powerful statistical analysis techniques, offers new insights into risk and performance that could lead to major improvements in investment reporting going forward. These indicators could well assist asset managers and institutional investors in selecting funds for any asset class. The process would of course be tailored to suit each specific asset management profile ■

“  The two formal measures of portfolio diversification - the Effective Number of Constituents and the Effective Number of Bets - afford asset managers a predictive view. ”