Sector Risk Model

Abstract

As demonstrated in previous chapters, quantitative portfolio optimisation and asset allocation are closely tied to the risk management process. This is true whether we work with total return and risk or active return and risk. When choosing an appropriate asset allocation, we do so in accordance with our preferences for the trade-off that exists between expected return and expected risk. Many of the investment decisions being made in asset management organisations today increasingly depend on a global sector perspective. Previously the focus was mainly on stocks versus bonds, and subsequently on domestic versus international equity. Country considerations were very much at the heart of the asset allocation process, because large diversification benefits can be obtained from placing assets in equity markets in a range of countries globally. This still holds true, since there are considerable differences between the economic environment in different countries and regions. However the focus is increasingly shifting to global sectors, as more and more sectors become part of a global marketplace and become subject to global competition. Many sectors are thus becoming global, in the sense that the companies that comprise these sectors (such as the information technology sector, the automobile sector or the pharmaceutical sector) compete internationally, and operate, buy and sell in several international markets and/or economic regions.