10 April 2019

Some Manage Portfolio Risk by Trusting “Magic”; We Do It (With) WISER!

By Ahmet E. Kocagil, PhD

Western Asset firmly believes that a strong risk management culture is fundamental to a successful investment management record. As Benjamin Graham once said, “the essence of investment management is the management of risks, not the management of returns.”

Investment is about taking calculated risks. Investment teams need to have a good understanding of the drivers of their portfolio risks, so that they can weigh the alpha themes they come up with against the related potential risks. For ideal portfolio construction and management, investors need to examine both the center of distribution risks, e.g., tracking error standard deviation (TE), volatility ratio (VR), etc., as well as portfolio tail-risks, e.g., value-at-risk (VaR), expected shortfall (ES), and stress and scenario testing.

Acknowledging the strategic importance of a sound and independent risk platform, Western Asset has developed our own proprietary risk system called WISER, which we began using in 2016.

WISER—the Western Information System for Estimating Risk—is a single risk system for all Western Asset portfolio and benchmark securities/constituents. The system supports leveraging best-of-breed security valuation models under a single risk umbrella to ensure consistent assumptions across models.

WISER provides four primary benefits:

  1. Independence: WISER analytics are based on and reflect Western Asset’s knowledge base and analysis of market conditions. Thus, they allow us to make our own decisions and assessments rather than following someone else’s.
  2. Quality: WISER offers accurate and high-quality risk analytics for use by:
    a) Risk managers and analysts to assess and dissect portfolio risk and analyze its drivers
    b) Portfolio managers, traders and analysts to enhance risk-adjusted decision making
    c) Client Service Executives to conduct more complete risk discussions with clients
  3. Quantity: WISER analyzes vast and comprehensive data sets.
    a) WISER currently covers virtually all fixed-income markets globally. In addition, later this year WISER coverage will also include global equities, as well as alternative assets. By June 2019, WISER will be equipped to cover virtually all capital markets
    b) WISER allows portfolios that Western Asset manages to be analyzed every day and can be easily scaled to handle more (e.g., model portfolios, client portfolios, etc.)
  4. Communication: WISER provides a lingua franca so that:
    a) Portfolio managers, traders and analysts can put Western Asset’s knowledge into risk analysis, to thereby increase buy-in
    b) Client Service Executives and product managers can obtain and share information in a way that helps clients see that their risk tolerances are being taken into account

WISER is a risk-factor-based model (with approximately 1,000 risk factors) that employs GARCH estimates in making forward-looking assessments for each factor. It provides parametric statistics (e.g., option-adjusted duration/key rate durations, option-adjusted spread duration, convexity, various yields and other Greeks), as well as distributional statistics on portfolios examined (via Monte Carlo), such as: TE, Vol, VR, VaR, expected shortfall, rho, beta and others.

In addition, WISER conducts a number of scenario tests to better examine the tail-risk sensitivities of portfolios. The reports generated show breakdowns of these metrics by risk factors, sectors, countries, currencies, security types and obligors so that we can drill down and analyze the risk drivers in a given portfolio. A schematic overview of WISER can be depicted as shown here:

Exhibit 1: WISER Overview
Source: Western Asset. Select the image to expand the view.

WISER can also be used interactively to assist with the decision-making process. Namely, users can:

  • Conduct “what if” analyses to see the risk and return impact of particular trades (at the CUSIP level) in a given portfolio
  • Assess potential risk impacts of asset reallocation in a given portfolio
  • Examine the capital efficiency (a la Solvency II) of trade ideas
  • Conduct custom scenario/stress-test analyses
  • Decompose the total risk change into active position changes versus passive market changes

Thus, the WISER risk analytics platform, with all of its reporting and on-demand capabilities, helps us at Western Asset to gain timely insight and foresight in risk managing our portfolios/funds, addressing client queries and providing better risk-adjusted investments for our clients.