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Introducing a Multi-Asset Dynamic Allocation

Aug. 29, 2016

Aug. 29, 2016

STOXX Ltd. has stepped up its multi-asset offering by introducing the EURO STOXX 50® Multi-Asset Momentum Risk Cap Indices, which track the performance of a portfolio of equities and bonds that shifts asset-class allocations depending on market momentum and within a range of pre-determined volatility tolerance levels.

The Multi-Asset Momentum Risk Cap Indices are comprised of an equity and a bond investment, using the EURO STOXX 50® and EURO STOXX 50® Corporate Bond indices of Eurozone issuers as asset components. They dynamically allocate exposure between the two based on the price momentum for each asset class. At the same time, those active and systematic allocations are governed by a volatility cap that limits how much can be placed on either part of the portfolio.  

The new concept follows the introduction in May of the EURO STOXX 50® Multi-Asset Indices, made up of shares and debt of blue-chip and liquid companies in the Eurozone with pre-defined fixed asset exposure levels. For more on this multi-asset approach, please click here.

A product tailored for each risk profile

Five different versions of the Multi-Asset Momentum Risk Cap indices offer portfolios with volatility ceilings at 5%, 7.5%, 10%, 15% and 20% to accommodate the risk profile of each investor.

The momentum of each asset class is calculated from their historical 60-day price performance. This aims to help investors capture the fluctuations of the market and macroeconomic environment, and what they say about future returns.

Balancing momentum and risk

The index methodology balances both factors: momentum and volatility.

If the volatility of the sub-index with the higher momentum is below the defined maximum risk level, 100% of the overall investment is allocated into this index. In this case, momentum is the sole driver of allocation as volatility is not a constraint.

If the sub-index with higher momentum violates the volatility threshold while the sub-index with the lower momentum falls below the threshold, a trade-off between volatility and momentum is sought. The maximum possible share is invested in the asset class with the higher momentum while adhering to the risk-cap.

If the risk levels of both sub-indices breach the risk ceiling, the total investment is allocated to the index with the lower volatility. The strategy here aims for “damage control,” ignoring the momentum signal.

Rather than target a specific volatility level, the indices use volatility as a risk threshold under which to enhance returns.  

Return and volatility control

The chart below displays the performance of the two underlying sub-indices, as well as that of a momentum-only strategy and of the EURO STOXX 50 Multi-Asset 10% Risk Cap index.

Source:STOXX

As can be seen, the momentum-only strategy outperformed by switching between the favored asset classes allocation displayed in lower section of chart. The Momentum + 10% Risk Cap strategy had a lower return than momentum-only, as the addition of a risk ceiling implied that the participation in the equity index was partially sacrificed to stick to the ex-ante defined maximum risk level. 

Risk-adjusted returns

An analysis of returns shows the Multi-Asset Momentum Risk Cap indices provide stability and risk-adjusted returns. Unsurprisingly, additional returns come with additional risk. Thus, the lower the risk tolerance, the lower the expected return.

As an illustration, the Multi-Asset Momentum 20% Risk Cap Index has gained an annualized 6.7% in the last five years, with annual volatility of 12.7% in the period, STOXX data show. The Momentum 5% Risk Cap Index has gained 5.8% per year, with volatility of 4.1%. That compares with annual returns of 6.3% and 5.4%, respectively, for the EURO STOXX 50 and the EURO STOXX 50 Corporate Bond indices. Volatility for the last two was, respectively, 22.4% and 2.3%.

Daily monitoring of allocations

While the Multi-Asset Momentum Risk Cap indices are rebalanced on a quarterly basis, they are conceived to check daily for abnormal changes in volatility and react to those emerging scenarios. To avoid excessive turnover, however, a 20% tolerance buffer to each volatility level is provided in those instances. For more information on the index methodology and calculation, please click here.

Cross-asset investing has shown its benefits in providing risk-adjusted outperformance, diversification and long-term returns. The new products add a rules-based and transparent option to this space and a new milestone in the ever-growing world of index investing. The combination of momentum and risk limitation is attractive for asset managers seeking a passive methodology to maximize returns with an uncorrelated and volatility-proof portfolio.

 

 

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