Axioma’s Quarterly Risk Review Sees an “Eerie Calm” Amid Concerns
With most markets posting strong gains in the third quarter, risk forecasts generated by Axioma’s risk models dropped, paralleling a decline in the VIX to its lowest level since 2007, according to the latest edition of Axioma Insight: Quarterly Risk Review, a comprehensive reference on the state of investment markets for portfolio managers, risk managers and other investment professionals.
“The data suggest an eerie calm in world financial markets, despite a raft of looming concerns, including the European debt crisis, the threat of a U.S. “fiscal cliff” and the slowing of growth in China,” said Melissa Brown, Senior Director, Applied Research and co-author of the report.
Axioma’s short-horizon risk forecast for the FTSE Developed Index was roughly half its level of a year ago and down 25% percent from the end of the second quarter. European and U.S. benchmarks showed similar results. While risk forecasts are low by recent standards, they remain above all-time lows, the report noted.
Brown offered several possible explanations: “The macro issues we are seeing in the headlines could already be baked into stock prices, and for that reason volatility has remained subdued. Or, the extreme uncertainty in current markets may have simply paralyzed investors, which would also have had a dampening effect on volatility. More ominously, this could also be the calm before the storm.”
Included in Axioma’s third-quarter Insight report is a special analysis of market liquidity, which indicates that investors may have held back in the third quarter. The analysis points to volume as a percent of total market capitalization, which peaked in October 2008 and has now settled back down to its pre-crisis levels. The decline in volume was pervasive and consistent across size, sector, and country, according to the report.
Brown cited several implications for active portfolio managers: “Since short-horizon forecasts tend to lead, medium-term forecasts are likely to drop in the fourth quarter, so active managers with turnover constraints may find themselves using their turnover budgets more for risk reasons than for alpha reasons—or they may need to increase turnover to satisfy their risk budgets.”
For the second consecutive quarter, statistical risk factors did not seem to pick up anything that was not reflected in the fundamental models, suggesting once again an absence of lurking risk and, hence, the reduced likelihood of a “surprise” in the coming months.
Axioma’s Quarterly Risk Review is currently available in eight editions:
• Asia Pacific Ex-Japan
• Emerging Markets
• Global Developed
Axioma Insight: Quarterly Risk Review is published by Axioma, Inc., a leading provider of decision support, risk analysis and portfolio rebalancing and performance attribution tools. The report can be accessed on the Axioma Insight page of the company’s website.