Practical analysis for investment professionals
25 January 2024

A More Robust Macro Risk Targeting Strategy for Equities

Investors who want to target exposure to macroeconomic risks in their equity investments can enhance the robustness of those portfolios with a new strategy that delivers more consistent exposures to macroeconomic factors.

That’s the critical takeaway of Graham and Dodd Award of Excellence-winning research from Mikheil Esakia and Felix Goltz. In “Targeting Macroeconomic Exposures in Equity Portfolios: A Firm-Level Measurement,” which earned the 2023 Graham and Dodd Top Award, Esakia and Goltz demonstrate how investors can more precisely target stock portfolios’ economic risk exposure than with strategies that allocate across sectors or equity-style factors.

I spoke with Esakia, a senior quantitative research analyst at Scientific Beta and a PhD candidate at EDHEC Business School, for CFA Institute Research and Policy Center for insights on their research findings and to produce an In Practice summary of the study. Below is a lightly edited and condensed transcript of our conversation.

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CFA Institute Research and Policy Center: What motivated you to conduct the research and author the paper?

Mikheil Esakia: Investors would typically use sector and style factor portfolios to manage the macroeconomic risks, and what really wasn’t there in the literature was an explicit attempt to try to improve this type of measure. One of the reasons we don’t see such equity products is because it’s very challenging to make portfolios that out of sample can give you the exposure that you want.

What is new or novel about your research?

I would say the contribution from our side is to have a focus on measurement of the link between equities and macroeconomic risks that allows you to maintain or predict the sensitivity out of sample in a proper way. The study demonstrates how investors can more precisely target stock portfolios’ economic risk exposure than strategies that allocate across sectors or equity-style factors.

In contrast to popular practice, we propose a systematic approach that is transparent and replicable. We also go beyond analyzing sector differences and instead exploit the firm-level heterogeneity of risk exposures. I think it’s novel when it comes to how macro risks are managed in practice.

What are the key innovations in the study?

The methodology to measure these exposures, including the selection of right macro variables, as well as building portfolios from stock-level rather than allocating across existing portfolios, makes our approach quite unique. Our approach is systematic and is intended to harvest both the long-term equity premium and to protect the portfolio from sudden changes in economic conditions.

What is the study’s key finding?

It is possible to construct equity portfolios that possess out of sample exposure that facilitate more precise targeting of levels of macroeconomic risk exposure.

How does your approach perform?

The long-term performance of dedicated macro strategies is very similar to that of the broad market portfolio. The stand-alone returns of eight macro exposure strategies as well as their Sharpe ratios are not significantly different from the market portfolio in the study’s sample. They also do not come with negative alphas in a multifactor model that includes the usual style factors.

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In what ways can practitioners apply the findings?

Investors can use the construction methodology for a variety of applications, including tilting long-only portfolios to target desired macroeconomic sensitivities. They can build equity portfolios that hedge undesired macroeconomic risks with reliable measurement of how different stocks are exposed to macroeconomic risks.

To whom do the paper’s findings apply? Who should be interested, and why?

Our methodology allows designing equity portfolios that would react to changes in investors’ expectations about economic conditions, such as short-term interest rates, the term spread, the credit spread, and breakeven inflation in portfolios. The approach should help investors whose portfolios may come with substantial exposures to such macroeconomic risks to better manage them.

For more on this research, check out the full article, “Targeting Macroeconomic Exposures in Equity Portfolios: A Firm-Level Measurement,” from the Financial Analysts Journal.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images / Kunakorn Rassadornyindee

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About the Author(s)
Mark Fortune

Mark Fortune has more than 30 years of experience as a financial writer and editor, with a focus on institutional investment management. He has worked in various editorial roles at organizations that include Institutional Investor, Pageant Media, Markets Group, and the New York investment management firm Cohen & Steers.

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