Many institutions are de-risking portfolios to reduce the likelihood of funding shortfalls from adverse market moves. Additionally, some institutional investors seek higher returns from higher risk asset classes in the hope of improving their funded status.
In these cases, equity markets are the key - reduce equities to lower risk or seek higher returns through high alpha (and usually higher risk) strategies.
Market cap-weighted indexes have become the de facto gauge of equity market risk and return, yet they are not perfect. Though they are typically a good proxy of the opportunity set they are meant to represent, they have two inherent flaws-they:
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Are prone to concentrations of risk and
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Have an inherent preference for over-valuation
The Financial sector is currently 21% of the global stock market but represents 40% of the risk.
Source: FTSE, JPMAM. FTSE Developed Index sector weights and risk as of 7/23/2014. Risk proportion equals the product of the squared sector weight and the squared 3 year trailing volatility as a percentage of the total.
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Tim Devlin
