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RISK MANAGEMENT | REGULATORY | MARKETS | INVESTMENT ACTIONS | PORTFOLIO DESIGN
Market risk monitor
Assessing current risks
October 2018
MKTG1018E-637924-1992215
BlackRock’s risk management philosophy
is underpinned by a belief that risk
positions should be deliberate, diversified
and appropriately scaled to conviction and
market conditions.
We seek to achieve that by measuring
and calibrating risk through a number of
key metrics.
Risk management cannot fully eliminate
the risk of investment loss.
2
A SSESSIN G C UR R E N T R IS K
MKTG1018E-637924-1992215
Content
This quarterly update provides an overview of the market risk environment
as at October 2018 through the analysis of five key components:
1 Volatility risk
2 Correlations and concentration
3 Persistence risk
4 Valuation risk
5 Event risk
It is our belief that understanding the market risk environment and its
implications for portfolio positioning may lead to better investment
outcomes. In particular, a greater understanding of market risk may allow
better calibration of portfolio risk for the purposes of targeting alpha and
achieving return objectives.
More detail on our approach and methodology can be found in our
introductory publication: The elements of risk: analysing changing
market conditions.
The opinions expressed are as of October 2018 and are subject to change
at any time due to changes in market or economic conditions. The above
descriptions are meant to be illustrative. There is no guarantee that any
forecasts made will come to pass.
MAR K E T R I S K MO NI TOR
3
MKTG1018E-637924-1992215
Overview
Bar a few exceptions, volatility declined over the quarter. While the change
in risk measures reported was marginal over the quarter, the recent spike in
volatility in an environment of rising interest rates warrants detailed attention
across the elements of risk. At this stage, it is too early to tell whether this is
a temporary spike, similar to the previous episodes we have experienced,
or the start of a prolonged period of risk aversion. The BlackRock Investment
Institute’s central scenario is still one of above-trend economic growth,
but we also note the decisive scaling back of monetary policy support
and event risk in the form of trade tensions and China-US tensions.
Moreover, we see stretched valuations in certain pockets of the market.
Taken together, these developments suggest a less straightforward risk
environment to navigate.
4
A SSESSIN G C UR R E N T R IS K S
MKTG1018E-637924-1992215
Volatility, the primary metric of market risk, declined
further over the quarter, with the VIX and MOVE indices
averaging respectively 13 and 50 basis points over the
last three months. These readings compare to longterm averages of 17.3 for the VIX index and 90bps for
the MOVE index respectively. Volatility across different
sections of the market was also subdued with the
monthly, realised cross-sectional volatility in the S&P
500 ending the quarter at 5.65 compared to a monthly
historical average of above 7. The theme of low risk
was also evident in our regime map, which ended the
quarter in the ‘risk-on’ quadrant.
What are key risks
to watch?
• Trade wars
• US-China relations
• Monetary policy
transition
While it is true that on balance risk taking continues
to be rewarded, this is only a partial picture given the
a higher probability of losses and a higher cost for
backdrop of monetary tightening and significant event
rolling over equity hedges. In addition, we see growing
risk, whether it is global trade discussions, US-China
valuation risk at the US and the UK overall market level,
tensions and uncertainty in Europe relating to Brexit and
suggesting increased vulnerability to rising interest
increased populism.
rates. Further themes within markets that could be a
potential source of risk include the persistence seen in
However, if we look beneath the surface, it is possible
‘quality’ stocks and the continued underperformance of
to capture some of the tension between low observed
‘value’ stocks, which have now translated into stretched
market volatility and the potential of a sudden increase
valuations for both market segments.
in both implied and realised volatility. One of those
metrics is the Chicago Board Options Exchange (CBOE)
While it remains to be seen whether the most recent
SKEW index, which measures the perceived asymmetry
spike will deviate from the recent trend of short-lived
in the returns to the S&P 500 index and the cost of
bouts of risk aversion, we believe that risk has increased,
hedging equity exposure more broadly. Data up to
meaning close monitoring of our elements of risk will be
quarter end show a marked move into negative territory
more crucial than ever.
compared to the long-term distribution, thus implying
MAR K E T R I S K MO NI TOR
5
MKTG1018E-637924-1992215
1
Volatility risk
Moderate, but skewed
What does exhibit 1a show?
The time series of the Chicago Board Options Exchange Volatility Index (VIX) and the Merrill Option
Volatility Expectations (MOVE)© indices since January 1990. Note that these series are correlated as
they are both influenced by systemic risk. The charts on page 7 show the level of observed skewness in
the S&P 500 option contracts over time.
Exhibit 1. Implied volatility
90
3.0
VIX Index
35
30
80
25
(%)
2.5
70
20
15
10
2.0
50
1.5
40
30
MOVE Index (%)
VIX Index (%)
60
VIX Index
Interquartile
range
Median
12 month
average
September 2018
MOVE Index
1.0
1.5
0.5
10
0
Jan
1990
0.0
Jan
1995
Jan
2000
Jan
2005
Jan
2010
Jan
2015
Sep
2018
VIX
MOVE
(%)
20
1.0
0.5
Interquartile
range
Median
12 month
average
September 2018
Index data provided for illustrative purposes only. Indices are unmanaged and it is not
possible to invest directly in an index.
Source: Chart by BlackRock using data from Bloomberg. Merrill Lynch and
Govt/FF&O Research – data in USD as at end of September 2018.
••
Implied volatility, measured across equities and bonds, was below its long-term median at quarter
end, continuing a long-term trend we have observed in markets.
••
While at the time of writing, we see some elevated risk aversion, the central scenario of above-trend
global growth appears unchanged. It therefore remains to be seen if the recent spike will be more
sustained in nature compared to the brief and sharp episodes of increased risk aversion seen over the
last few years.
6
A SSESSIN G C UR R E N T R IS K S
MKTG1018E-637924-1992215
What does exhibit 1b show?
The skew in the return distribution of the S&P 500 implied by out-of-the-money option contracts.
Exhibit 1b. Levels of skewness in VIX contracts
0
SKEW Index
0
-1
-1
-2
-2
-3
-3
-4
-4
-5
-5
-6
Interquartile
range
Median
-7
Jan
1990
Jan
1995
Jan
2000
Jan
2005
Jan
2010
Jan
2015
Sep
2018
12 month
average
September 2018
Index data provided for illustrative purposes only. Indices are unmanaged and it is not possible
to invest directly in an index.
Source: Chart by BlackRock using data from Bloomberg – data in USD as at end of
September 2018.
••
The chart maps the evolution of the skew or the price of tail risk of the S&P 500.
••
While the skew is below zero throughout the period covered, recent data have moved
further into negative territory, suggesting increased perceived tail risk.
MAR K E T R I S K MO NI TOR
7
MKTG1018E-637924-1992215
What does exhibit 2 show?
The cross-sectional volatility seen in the S&P 500 since 1965. Elevated levels of cross-sectional volatility
speak to higher return dispersion across assets. Other things being equal, active risk in a portfolio
often varies 1:1 with cross-sectional volatility, but not with absolute risk.
Exhibit 2. Cross-sectional volatility in the S&P 500
35
S&P 500 Index
14
Cross-sectional volatility (%)
Cross-sectional volatility (%)
30
25
20
12
10
8
15
6
10
4
S&P 500 Index
5
Interquartile
range
Median
0
Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Dec
2017
12 month
average
September 2018
Index data provided for illustrative purposes only. Indices are unmanaged and it is not possible
to invest directly in an index.
Source: Chart by BlackRock using data from MSCI and BlackRock – data in USD as at end of
September 2018.
••
The dispersion in realised returns that we measure, using the S&P 500 as the reference index, fell
over the quarter to 5.65% compared to a long-term monthly average of 7.67%.
••
Even taking into account the recent surge in market volatility, cross-sectional volatility at the time of
writing remains close to its 12-month average of 6.1%.
8
A SSESSIN G C UR R E N T R IS K S
MKTG1018E-637924-1992215
2
Correlations and concentration
A more complex picture
What does exhibit 3 show?
The correlations across asset classes as represented by their respective market index. A low number
(green) indicates weak correlation, a high number (red) indicates strong correlation of either sign.
IL debt
Dev sov debt
IG debt
EM sov debt
HY debt
Dev equity
Dev sml cap
equity
EM equity
Listed private
equity
Infrastructure
Property
Commodities
ex energy
Energy
Exhibit 3. Correlation across asset classes
IL debt
1.00
0.82
0.73
0.33
0.16
-0.15
-0.14
0.02
-0.15
0.31
0.29
-0.08
0.05
Dev sov debt
0.82
1.00
0.81
0.39
0.14
-0.23
-0.24
-0.07
-0.27
0.35
0.26
-0.19
-0.09
IG debt
0.73
0.81
1.00
0.60
0.43
-0.02
-0.06
0.16
-0.07
0.41
0.41
0.02
-0.05
EM sov debt
0.33
0.39
0.60
1.00
0.52
0.21
0.11
0.48
0.14
0.37
0.35
0.14
0.09
HY debt
0.16
0.14
0.43
0.52
1.00
0.53
0.51
0.51
0.46
0.49
0.46
0.24
0.28
Dev. equity
-0.15
-0.23
-0.02
0.21
0.53
1.00
0.91
0.67
0.84
0.57
0.57
0.21
0.24
Dev sml cap
equity
-0.14
-0.24
-0.06
0.11
0.51
0.91
1.00
0.57
0.83
0.48
0.56
0.21
0.25
EM equity
0.02
-0.07
0.16
0.48
0.51
0.67
0.57
1.00
0.57
0.45
0.52
0.38
0.28
Listed private
equity
-0.15
-0.27
-0.07
0.14
0.46
0.84
0.83
0.57
1.00
0.48
0.45
0.20
0.20
Infrastructure
0.31
0.35
0.41
0.37
0.49
0.57
0.48
0.45
0.48
1.00
0.70
0.09
0.15
Property
0.29
0.26
0.41
0.35
0.46
0.57
0.56
0.52
0.45
0.70
1.00
0.18
0.17
Commodities
ex energy
-0.08
-0.19
0.02
0.14
0.24
0.21
0.21
0.38
0.20
0.09
0.18
1.00
0.16
Energy
0.05
-0.09
-0.05
0.09
0.28
0.24
0.25
0.28
0.20
0.15
0.17
0.16
1.00
N/A
High
Medium to high
Low
Index data provided for illustrative purposes only. Indices are unmanaged and it is not possible to
invest directly in an index. Source: BlackRock – data as at end of September 2018, Bloomberg, Reuters.
Notes: Indices used are the Bloomberg Barclays World Govt Inflation Linked bonds TR USD for
IL debt; Citi WGBI 7-10yr local currency for Dev sov debt; Bloomberg Barclays Global Aggregate
Corporate Total Return Index USD for IG debt; J.P. Morgan EMBI Plus Composite USD for EM sov
debt; Bloomberg Barclays U.S. Corporate High Yield Total Return Index for HY debt; MSCI World
Gross Total Return Index local currency for Dev equity; MSCI Daily TR Gross Small Cap World USD
for Dev sml cap equity; MSCI Daily TR Gross EM USD for EM equity; S&P Listed Private Equity
Total Return Index USD for Listed private equity; S&P Global Infrastructure Total Return USD for
Infrastructure; FTSE EPRA NAREIT Developed TR USD for Property; Bloomberg ex Energy subindex
USD for Commodities ex energy; Bloomberg sub Energy Index USD for Energy.
••
The overall correlation between asset classes as represented by indices continues to be low with
sovereign bonds and global equity remaining negatively correlated.
••
Low correlations between the commodities block and the other indices also drove the overall
correlation down.
MAR K E T R I S K MO NI TOR
9
MKTG1018E-637924-1992215
What does exhibit 4 show?
The time-varying relationship between risk and return as well as correlations between the different
asset classes listed in exhibit 3, as represented by their respective market index. On the X-axis,
we measure diversification and on the Y-axis, the reward to risk.
Sentiment – Risk Tolerance Index
Exhibit 4. Risk premia and diversification opportunities
Concentration – Multi-Asset Concentration
2018 YTD
2017
Source: BlackRock – data as at end of September 2018.
••
At the end of the quarter, the regime map still suggested an environment that was broadly
supportive for risk taking.
••
However, the level of change we have seen in risk sentiment and concentration levels since the start
of the year has been significant.
10 A SSESSIN G C UR R E N T R IS K S
MKTG1018E-637924-1992215
Persistence risk
Quality bias
What does exhibit 5 show?
It illustrates the ability of style factors to explain one-year price momentum in global equities,
as measured by the MSCI All Country World Index. Higher values indicate concentration in the
sources of return.
Exhibit 5. Persistence risk
50
40
30
(%)
3
20
10
0
Dec
2010
Dec
2011
Dec
2012
Dec
2013
Dec
2014
Oil
Dec
2015
Dec
2016
Value
Dec
2017
Volatility
Sep
2018
Size
Index data provided for illustrative purposes only. Indices are unmanaged and it is not
possible to invest directly in an index.
Source: Chart by BlackRock using data from Reuters and BlackRock – data in USD as at end of
September 2018.
••
In the above chart, we measure the correlation between relative returns of stocks and their
corresponding security characteristics, specifically exposure to the oil price, value, volatility and size.
Significant concentration in exposures is an important indicator to monitor as it suggests increased
market vulnerability.
••
Negative returns to value and positive returns to quality were still a key feature of global equity
markets over the quarter, increasing the level of momentum concentration further. The recent
positive performance of securities that are cheap relative to their earnings means that this
concentration measure has gone down at the time of writing, but only marginally.
MAR K E T R I S K MO NI TOR
11
MKTG1018E-637924-1992215
Absolute valuation risk
Some pressure
What does exhibit 6 show?
It shows the current value and the long-term distribution of cyclically adjusted earnings yields for major
global equity markets relative to the risk-free rate in those markets. In the same context, we also show
spreads for high yield and emerging market bonds.
Exhibit 6. Historical distribution of EPS/ price and spreads
12
(%)
 Cheaper
10
8
6
4
2
Expensive 
4
0
-2
-4
S&P
500
TOPIX
Japan
MSCI
Europe
Interquartile range
FTSE All
MSCI
SHARE – Emerging
UK
Markets
Median
US
high
yield
European Emerging
high
market
yield
bonds
12 month average
US
10yr rate
September 2018
Time period varies according to data availability. EPS is trailing 12-month averaged over 10 years.
Source: Chart by BlackRock using data from Bloomberg and BlackRock – data in local currency for
each market as at end of September 2018
••
Equity markets appear relatively more expensive compared to their 12 month average.
••
For most indices, the measure is nevertheless within the interquartile range of their historical distributions
with the exception of the US and the UK, suggesting some valuation risk as interest rates rise.
••
While spreads across US high yield, European high yield and emerging markets bonds have steadily
risen this year, they still appear low relative to their long-term distributions.
12 A SSESSIN G C UR R E N T R IS K S
MKTG1018E-637924-1992215
Relative valuation risk
Some concern
What does exhibit 7 show?
Exhibit 7 shows the distribution of the relative valuations of segments of the market (MSCI World Index),
based on the forward earnings yield for the next fiscal year of the quintile of stocks most exposed to the
below factors.
Exhibit 7. Valuation of different market segments
 Cheaper
60
(%)
20
Expensive 
80
0
40
-20
-40
Momentum
Interquartile range
Volatility
Median
Value
12 month average
Quality
September 2018
Time period varies according to data availability. EPS is calculated as the trailing earnings
12-month averaged over 10 years divided by the current price.
Source: Chart by BlackRock using data from Bloomberg and BlackRock – data in USD as at end
of September 2018.
••
The relative valuation chart plots the percentage difference between the earnings yield offered by
certain markets segments, for instance ‘value’ or ‘quality / profitability’, and the market median.
••
The data as of the end of September ties in with the persistence seen in value and quality factors
and shows some significant stretched valuations in these pockets of the market.
MAR K E T R I S K MO NI TOR
13
MKTG1018E-637924-1992215
Event risk
Significant uncertainty
What does exhibit 8 show?
It shows, through principal component analysis, how different event risks are correlated to a small
number of key factors.
Exhibit 8. Correlation mapping of scenarios
1.0
0.8
Russia-NATO Conflict
0.6
Principal component 1
5
0.4
0.2
Tensions in
the Gulf
Fragmentation in Europe
Major
Terror Attack
Major
Cyber Attack
LatAm Populism
0
North Korea Conflict
South China Sea Conflict
-0.2
US-China Relations
-0.4
Global Trade Tensions
-0.6
-0.1
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Principal component 2
This chart is for illustrative purposes only. There is no guarantee that these scenarios will
occur. Scenarios are subject to change. We highlight only what we believe to be the main
scenarios, but these should not be construed as recommendations or advice. Principal
components 1 and 2 respectively capture the largest and second largest drivers of
divergence between scenarios.
Source: Chart by BlackRock using data from Bloomberg and BlackRock – data as at end of
September 2018.
Event risk remains a major concern. Using insights from the BlackRock Investment Institute, we monitor
and analyse a wide range of event risks, i.e. future events that may impact financial markets, but are
absent in historical data. The BlackRock geopolitical risk dashboard provides more detail on the key
risks and their potential impact on the markets.
14 A SSESSIN G C UR R E N T R IS K S
MKTG1018E-637924-1992215
Conclusion
Over the past quarters, we have argued that close monitoring of our risk
metrics remains essential, despite the broadly favourable risk environment. In
one sense, this is not surprising: the ability to scrutinise and interpret risk in a
systematic manner regardless of the prevailing backdrop is a key tenet of good
risk management. However, it is often harder to do so in periods of relative calm,
particularly when we see a long-term pattern of below volatility interspersed with
limited, albeit steep rises in volatility taking hold. It is too early to tell if the recent
rise in volatility will fit that previous pattern or is the start of an extended period
of increased risk aversion. What we know, however, is that the long-awaited shift
away from monetary easing is now taking place. This is likely to result in a very
different backdrop. In combination with the major event risk and some concerns
around momentum and valuations in certain areas, we believe this calls for
increased vigilance.
MAR K E T R I S K MO NI TOR
15
MKTG1018E-637924-1992215
Important information
This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or
MiFID Rules) and Qualified Investors only and should not be relied upon by any other persons.
Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial
Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: 020 7743 3000.
Registered in England No. 2020394. For your protection telephone calls are usually recorded. BlackRock is
a trading name of BlackRock Investment Management (UK) Limited.
Past performance is not a reliable indicator of current or future results and should not be the sole factor of
consideration when selecting a product or strategy.
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Any research in this document has been procured and may have been acted on by BlackRock for its own
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not constitute investment or any other advice and are subject to change. They do not necessarily reflect
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16 A SSESSIN G C UR R E N T R IS K S
MKTG1018E-637924-1992215
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