January 29, 2014 - Mid-year anxiety over both Fed tapering and slowing growth in China, plus worries about the impact of the US government shutdown, drove market risk to a peak in the second quarter of 2013, but it was all downhill after that, with levels of risk in most markets ending the year lower than where they started, according to an analysis of 2013 trends in risk by Axioma, Inc., a leading provider of advanced tools for risk management and portfolio construction.
"Although it was 'risk off' for many investors at mid-year, large cap US stocks ended up having their best year since 2003, despite the government shutdown, with consumer discretionary stocks leading the way," said Melissa Brown, Senior Director of Applied Research at Axioma. "Relatively safe utilities brought up the rear of US sectors, albeit with positive return that might have looked quite strong in a different environment."
Brown is co-editor of Axioma Insight: Quarterly Risk Review, which examines the state of risk worldwide by analyzing trends in Axioma's Robust Risk Models.
The year was characterized in part by a shift in risk from west to east, though the change had more to do with trends in the west rather than the east.
"One of the most significant trends of 2013, which seems to be continuing into 2014, was the continued decoupling of developing markets from emerging markets," said Brown. "We saw it across the board, in equity, bond, currency and CDS markets. The divergence of risk and return had major investor implications in terms of stock and country selection in emerging markets."
After several years in which economic concerns revolved around certain countries and the euro, European markets saw their risk fall, especially after the second quarter. US and North American markets also experienced a decline in risk, while risk in Asian markets, with the exception of Japan, was flat-to-up over the past year. Emerging markets fared less well, with even the historically better-performing markets underperforming developed markets.
"Europe shook off many of its recent woes, as returns in both Greece and Ireland both soared," added Brown. "Spain and Italy also had strong returns, and with less volatility than Ireland and Greece. Although this year seems to be starting on shaky ground, concerns remain focused on emerging equity and currency markets"
Domestic economic concerns in Japan drove risk sharply higher, though as worries faded the fall-off was equally dramatic.
Lower factor correlations and asset correlations also contributed to the decline in risk developed markets. Individual asset-asset correlations fell to levels not sustained since the mid-to-late 2000s. Factor correlations also fell in emerging markets, but the impact of the decline was largely offset by higher factor volatility.
"Lower correlations, along with the changes in risk geographically, resulted in investors becoming much more discriminating," said Brown. "In the absence of a single overarching theme driving returns, investors placed their 2013 bets based on the individual merits of countries and individual assets within countries. Since year-end, correlations have risen somewhat, although at this juncture they are still low relative to historical levels"
Although low correlations often suggest a good environment for stock pickers, when combined with low volatility, it frequently means a difficult year for active managers. "Decent factor returns, especially for momentum, may have made the environment a little more conducive to quant manager outperformance in 2013," said Brown.
"Of the regions we track, only the US saw lower-than-average monthly momentum returns in 2013, although on a risk-adjusted basis even in the US performance looked quite good," said Brown. "Overall, on a risk-adjusted basis, momentum was far stronger than average in every region for the last 12 months."
From a historical perspective, despite the second-quarter blip, risk in 2013 overall remained much closer to historically low levels than to high levels, and continues to be at relatively low levels into January noted Brown.
Looking ahead, while low risk often prompts concerns among investors about an impending increase, nothing on the horizon (based on Axioma's risk data) suggests more than a temporary uptick ahead, said Brown. She adds "of course we will be watching this issue closely to ascertain whether more significant changes in risk are in the offing."
Axioma provides daily risk monitors for the US, Europe, Asia-Pacific ex-Japan, Japan, China, Australia, Taiwan, Emerging Markets, and Global Developed on its website. Axioma Insight: Quarterly Risk Review is also available on the site.
