Financial Models: When Everything Goes Up, Risk Goes Down

Here’s how standard risk metrics continue to be dangerous.

Morgan Stanley has highlighted that the positioning beta, a measure of risk, for emerging market bond funds appears to have come down against their benchmarks.

Yet as Morgan Stanley’s Regis Chatellier points out, a prime reason for this has been because market volatility for emerging markets has come down. There hasn’t been a major change in funds’ actual positioning.

Morgan Stanley: After reaching a peak this summer, net risk exposure – as captured by our positioning beta – has fallen to the point where EM funds are now neutral relative to their benchmark (see graph of positioning beta exposure on the left). This fall in beta risk exposure is largely due to a decline in EM bond volatility rather than a change in funds’ positioning. In fact, EM funds have been simultaneously overweight selective high-beta credits which have seen their volatility decreasing (in particular Argentina) and have increased their exposure to low-beta credits (notably Mexico), the combined result being a sharp decline in beta exposure versus benchmark.

We’re not faulting Morgan Stanley, their technical piece clearly states the situation and in fact highlights the issue. We’re just hoping that fund managers don’t truly view themselves as positioned with less risk right now just because almost everything went up in the last few months and volatility came down. Volatility can change quite quickly.

Pros Pull Out of EM Debt

But it was all because of falling market volatility:

Pros Pull Out of EM Debt

(Via Morgan Stanley, “EM Funds’ Net Risk Exposure Declining”, Regis Chatellier, 27 October 2009)

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