Do You Know What Macro Factors Are Driving Your Portfolios?

You may not be actively targeting macro factors in your portfolios, but it’s impossible to sidestep these elephants in the room.  Intended or not, we’re all running macro-factor portfolios to some extent.

BlackRock recently analyzed nearly 10,000 portfolios managed by financial advisors using a macroeconomic lens and found “large common patterns and significant exposures to just a few factors.”  The main factor exposure: economic volatility. 

“We find that advisor portfolios are dominated by exposure to economic growth,” writes Brian Lawler (a member of BlackRock’s portfolio solutions group) and several colleagues in “Factors and Advisor Portfolios.”  Accordingly, if you’re interested in understanding the primary source of risk premia, spending some time with macro-economic models is worthwhile and arguably essential.

The paper identifies six leading macro-economic factors, including real interest rate changes, inflation and economic growth.

This is hardly an exhaustive list, although it captures the big picture synopsis of the macro landscape from an investment perspective.  In theory, there’s a virtually infinite number of factors.  In practice, the relevant list looks more or less like the inventory assembled by BlackRock.

The larger issue is recognizing that regardless of how you’re running a portfolio, there’s probably a macro model just below the surface that’s influencing results, perhaps dramatically at times.  That’s not always front and center in investors’ minds, in part because sometimes the macro influence is hiding behind a market factor.  The obvious example: stock market beta.  The real driver, of course, is the economy, at least over the medium-to-long-term horizon.

One of the associated insights the paper shares is that “portfolios can be improved, particularly in preparation for economic slowdown by increasing exposure to other macro factors.”  The researchers also note that there’s opportunity to enhance risk management by diversifying beyond the size factor, which tends to dominate within equity allocations.

Advisors also tend to overweight credit risk and underweight interest-rate risk.  “This combination produces more stability through better balance of rate risk and credit risk, but mitigates the bond sleeve’s ability to provide maximum diversification of the overall portfolio.”

Should you manage money with a macro model proper?  There are certainly advantages on this front. As the BlackRock paper reminds, “An abundance of research literature has shown that these macro and style factor exposures are rewarded with excess returns over the long run, to compensate investors for bearing risk.”

Minds will differ on how or if a given portfolio strategy should be changed to reflect the macro-factor observations laid out by BlackRock.  But one thing is clear: investors can’t escape the macro-economic influence.  When you study risk premia, everything has one or more macro risk factors running the show, or at least casting a long shadow.

By James Picerno, Director of Analytics

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