Exploring Macroeconomic Sensitivities: HowInvestments Respond to Different Economic Environments

Abstract

A growing number of investors view their portfolios as a collection of exposures to risk factors. Risk-based investing can mean different things to different investors, but the common feature is the emphasis on improved risk diversification. Many investors identify risks primarily as asset class exposures; others may look at underlying macroeconomic exposures, such as inflation sensitivity. The difficulty with the latter approach is that macroeconomic factors are not directly investable. In this article, the authors study the sensitivity of traditional asset classes and dynamic strategies to different macroeconomic environments: growth, inflation, real yields, volatility, and illiquidity. They identify environments that are particularly challenging for investors and find evidence that dynamic systematic strategies, known as style premia, have meaningfully less macro exposure than do asset classes. They also show how diversification reduces portfolios’ macro risk exposures.