Global Leveraged Market Neutral Strategy Approach to Risk Management

February 2015

Philosophy

Acadian’s investment objective for the Global Leveraged Market Neutral (GLMN) strategy is to derive the majority of return from market-agnostic stock selection, driven by optimal exposures to our fundamental and technical drivers of equity returns. We see this exposure as compensated risk. Conversely, we seek to eliminate or minimize exposure to all other sources of equity returns which we view as uncompensated risk. With that in mind, our approach to “market neutral” spans beyond the typical definition of simple neutrality to the broad equity market. We additionally target neutrality to directional risks such as industry or currency, and to risk premia such as market capitalization or volatility. 

Risk Target and Leverage

Acadian adjusts gross leverage in the GLMN strategy to target an annualized realized volatility between 10% and 12%. The maximum gross leverage is 500%, 250% per side. The maximum gross volatility is constrained at 14% annualized, as estimated by Acadian’s proprietary risk model. Our realized volatility since inception is 10.5% annualized (gross returns).1

Figure 1

fig 1
 
Schematic representation of risk breakdown. These do not represent actual values from strategy.

Sources of Investment Risk

Expanding on the view that all systematic (fundamental or technical) drivers of equity returns offer either compensated or uncompensated risk, and that we aim to maximize the former while eliminating the latter, it is intuitive to offer the following definition of strategy risk: 
total risk = systematic uncompensated risk + compensated alpha risk + company-specific risk

We directly manage all three individual components as well as the total. 

Total Risk

We constrain maximum total risk at 14% without making an attempt to minimize it. Within the context of consciously taking exposures to fundamental and technical drivers of equity returns, which represent the largest source of risk and the potential associated reward (return), minimizing total risk is not sensible. 

Systematic Uncompensated Risk

By maintaining very low exposure to each risk factor, we arrive at a persistently near-zero contribution to the strategy’s risk and return from the entire group of uncompensated risk measures shown in Figure 1. We do not employ risk aversion parameters, which would require us to consider the long-term covariance structure of the risk factors. We believe such long-term risk covariance structures are inherently unstable and introduce further uncompensated risk. 

Compensated Alpha Risk

We directly measure the risk of Acadian’s alpha factors and target a particularly balanced structure of the alpha risk budget of the strategy. We believe that the largest inflection-point risk to a market neutral strategy enters through overconcentration of portfolio risk in a factor or a group of factors that become more volatile and/ or correlated than estimated. We attempt to prevent such overconcentration by redistributing the excess risk. Additionally, we use proprietary tools to monitor the alpha risk structure, aiming to identify any potential structure changes that may not be captured by our systematic process. 

Company-Specific Risk 

With 1000+ positions in the strategy and a maximum initial position size of 100 bps (with tolerance up to 175 bps), even an outsized return in any given company cannot introduce significant risk to the strategy. Company-specific risk is largely diversified away. However, to further enhance the risk profile, we employ position-level Dynamic Asset Bounds (DAB). DAB reduces maximum allowed position size when the volatility of a given stock increases. The goal of the DAB constraint is to prevent losses from any individual position to exceed 15 bps due to an adverse move of 1.75 standard deviations of a stock’s monthly volatility.2 

To summarize, it is appropriate that the biggest portion of the strategy’s risk is the compensated risk of taking exposures to the fundamental and technical drivers of stock selection (alpha). We manage that risk both through optimal factor model weights and through a portfolio’s alpha risk budgeting.

Indirect Managed Costs

Liquidity Risk 

The strategy’s liquidity is managed explicitly. The liquidity limits are set such that approximately three quarters of the strategy’s assets are held at less than one day’s average volume. This is managed through the following set of constraints: 

  • Minimum market cap of at least $100 million. 
  • Daily volume3 (DV) of at least $0.5 million. 
  • Daily maximum of volume traded in any given stock cannot exceed 20% of the DV of that stock. In practice, the average value traded is approximately 5% of DV. 
  • Maximum holding constraint cannot exceed 300% of DV on the long side, and cannot exceed 200% of DV on the short side. Both limits have a tolerance of 100% of DV in order to account for high variability in daily volume. 

Factor Timing Risk 

Given that our strategy employs some elements of factor timing through Dynamic Factor Weighting (DFW), we appreciate there is a potential timing exposure risk. The DFW model is deployed in a reasonably slow fashion and each factor weight is managed within stable bounds. No factor weight will ever be taken down to zero or negative. Similarly, as previously mentioned, concentration of risk in one or more correlated factors is not allowed by design. 

Second-Order Exposure to Macro Events ("Risk of the Unknown")

We appreciate that while there are long-term fundamental drivers of equity returns, there are also strong contemporaneous sources of systematic risk. Exposures to such risk sources may not be easy to measure. For example, by construction, we will be neutral to a country which may hypothetically default on its debt, and we will not have directional exposure to financials in such a country. At the same time, there could be companies around the globe whose businesses are indirectly, to various degrees, exposed to the events in question. We have a framework in place for estimating such indirect exposure and constrain directional net exposure to the underlying events. Our aim is to minimize the probability of having a binary directional bet on the outcome of any macro event we do not model directly.

Figure 2

fig 2 

Appendix

Uncompensated Systematic Risk Limits and Other Constraints

We explicitly target near-zero exposure to the following set of continuous and discrete factors. 

Market Segment/Factor

market segment factor

Additionally, we typically control the following risk and liquidity parameters: 

Parameters (Typical Portfolio)

parameters
 

Footnotes

 1 The data presented here is for a Global Leveraged Market Neutral representative portfolio and is supplemental to the composite performance disclosure page attached. Investors have the opportunity for losses as well as profits. Past performance is no guarantee of future results. Performance inception: November 1, 2010.
2 Measured daily over the trailing 60 days and expressed in monthly volatility terms
3 Measured as median volume over the trailing 21 days
4 Relative to LMV (Long Market Value) 
5 The exposure is to Acadian’s size score, which is based on market capitalization. The size score follows a close-to-normal distribution within each country. A 1% exposure to the size score amounts to the longs being about $30 million smaller in market cap than the shorts, in median terms. In other words, the strategy does not have a meaningful size tilt. 
6 The exposure is to Acadian’s volatility score, which is based on a stock’s trailing 60-day realized volatility. The volatility score has a close-to-normal distribution. A 1% exposure to the volatility score amounts to the longs having 0.2% more annualized volatility than the shorts. The strategy does not have a meaningful volatility tilt.

Performance Disclosure - Global Leveraged Market Neutral Equity Composite

performance disclosure 
*Performance Inception: November 1, 2010. This composite was created on December 1, 2010. All figures stated in USD. 
Acadian Asset Management claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Acadian Asset Management has been independently verified for the periods January 1, 1994 through December 31, 2013 by Ashland Partners & Company LLP. A copy ofthe verification report is available upon request.Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. Reference to the benchmark is for comparative purposes only and is not intended to indicate that the composite will contain the same investments as the benchmark. Investors have the opportunity for losses as well as profits. Past performance is no guarantee of future results. Acadian Asset Management is an investment adviser specializing in global equity management. Acadian Asset Management is defined to include assets managed by Acadian Asset Management LLC, an investment adviser registered with and regulated by the United States Securities and Exchange Commission, as well as assets managed by its three wholly-owned affiliates, Acadian Asset Management (Japan), registered with the Kanto Local Financial Bureau, Acadian Asset Management Singapore Pte Ltd, authorized by the Monetary Authority of Singapore, and Acadian Asset Management (UK) Limited, authorized and regulated by the Financial Conduct Authority of the United Kingdom. 
Methodology: Returns are net of estimated foreign withholding taxes on dividends, interest, and capital gains. As of January 1, 2010 Acadian’s methodology was augmented to produce a more accurate gross return figure by eliminating modest cash flows such as securities lending income and custodial fees which are regarded as independent of the investment management process; the reinvestment of all income and trading expenses continue to be included. Gross returns will be reduced by investment advisory fees and other expenses. Monthly composite results are asset-weighted by beginning-of-month assetvalues of member portfolios which are geometrically linked to arrive at the annual composite return. Net-of-fee performance is accrued on a monthly basis and is calculated using the highest management fee as described in section 2A of the firm’s Form ADV for the investment process utilized to manage this strategy; such form is available upon request. Net-net-of-fees additionally include incentive fees which, when applicable, are also accrued on a monthly basis. The standard fee schedule for accounts managed with this product is 2% on assets managed and 20% of annual absolute performance. Management fees may vary according to the range of services provided, investment performance, and the amount of assets under management. Constituent portfolios are included from the first full month after inception to the present or the last full month prior to cessation of the client relationship with the firm. For example, an account that opened January 15, 2010 will be included beginning February 1, 2010. An account that terminated February 12, 2010 will be included through January 31, 2010. Composite performance and corresponding statistics above, specifically with regard to the wayincentive fees are recognized, reflect Republishing changes that went into effect on August 1, 2013. Policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. 
Dispersion: Acadian’s broad definitions are mainly the product of a highly customized process that may result in modest differences with regards to portfolio characteristics among constituents. All accounts managed with directly comparable investment objectives are included, though it’s possible for members to utilize slightly different benchmarks in optimizationand reporting. Although at times dispersion among constituents may be high, the long-term forecast for each portfolio is consistent with the overall composite. The Dispersion statistic presented above is an annual, asset-weighted standard deviation calculation performed only on those portfolios who have been members for the entire calendar year. Thirty-six months are required to calculate the „Three Year ex-Post Standard Deviation statistic. These figures are not shown if the requirements necessary to perform the calculations are unavailable. 
Composite Description: This composite invests globally in long and short equity positions in developed and emerging markets. The strategy targets a net beta neutral exposure by maintaining equal values for the long and short components and is significantly leveraged. The leverage component will typically exceed more than twice the value of the underlying investedcapital. As of February 1, 2012 this composite was renamed from “Global Leveraged Long/Short Equity Ltd.” A complete list of the firm’s composites and their descriptions is available upon request. 
Benchmark Description: The benchmark is comprised of the One Month U.S. T-Bill through June 30, 2012 and the 90-Day U.S. T-Bill as of July 1, 2012 through the present. These t-bills are discount bonds issued by the United States Treasury.

For institutional investor use only. Not to be reproduced or disseminated. For illustrative purposes only. This should not be considered a recommendation to buy or sell any specific security.

General Legal Disclaimer

Acadian provides this material as a general overview of the firm, our processes and our investment capabilities. It has been provided for informational purposes only. It does not constitute or form part of any offer to issue or sell, or any solicitation of any offer to subscribe or to purchase, shares, units or other interests in investments that may be referred to herein and must not be construed as investment or financial product advice. Acadian has not considered any reader’s financial situation, objective or needs in providing the relevant information.


The value of investments may fall as well as rise and you may not get back your original investment. Past performance is not necessarily a guide to future performance or returns. Acadian has taken all reasonable care to ensure that the information contained in this material is accurate at the time of its distribution, no representation or warranty, express or implied, is made as to the accuracy, reliability or completeness of such information.

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Acadian’s quantitative investment process is supported by extensive proprietary computer code. Acadian’s researchers, software developers, and IT teams follow a structured design, development, testing, change control, and review processes during the development of its systems and the implementation within our investment process. These controls and their effectiveness are subject to regular internal reviews, at least annual independent review by our SOC1 auditor. However, despite these extensive controls it is possible that errors may occur in coding and within the investment process, as is the case with any complex software or data-driven model, and no guarantee or warranty can be provided that any quantitative investment model is completely free of errors. Any such errors could have a negative impact on investment results. We have in place control systems and processes which are intended to identify in a timely manner any such errors which would have a material impact on the investment process.


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Acadian Asset Management LLC is registered as an investment adviser with the U.S. Securities and Exchange Commission. Registration of an investment adviser does not imply any level of skill or training.


Acadian Asset Management (Japan) is a Financial Instrument Operator (Discretionary Investment Management Business). Register Number Director General Kanto Local Financial Bureau (Kinsho) Number 2814. Member of Japan Investment Advisers Association.


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