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Quantitative Research and Risk Management
Our Quantitative Research, Risk Management, and Portfolio Analysis groups focus on the development of proprietary quantitative research, portfolio risk management, and client portfolio analysis. The groups have independent reporting lines directly to the Head of Prudential Fixed Income, ensuring the separation of the risk management and portfolio management functions.
The quantitative research team develops proprietary quantitative models to support relative value trading and asset allocation for portfolio management as well as various risk models to support risk management.
Case Study #1
In practice and as an example, the Emerging Markets Debt team employs our proprietary emerging markets yield curve models to assist in evaluating the relative values of individual securities across a number of dimensions: i) on each emerging markets sovereign and local market yield curve, ii) against other similarly-rated securities, and iii) between emerging markets corporate and sovereign issues. These models facilitate the curve strategies and other positioning done in client portfolios. Portfolio managers then compare the relative value assessments against the fundamental research conducted by the emerging market credit analysts.
Case Study #2
In another example, the Global Rates and Securitized Product team employs our proprietary Agency MBS models in addition to a proprietary regression tool to analyze and select mortgage-backed securities for client portfolios. We supplement our use of a traditional prepay model with an implied prepayment framework, which is a market-based gauge of expected prepayment behavior. The portfolio managers use these models to identify each security’s fundamental value, that is, the difference between its actual market price and its quantitatively-derived theoretical price. Our mortgage sector specialists perform regression analysis on spreads among sectors and individual securities within the mortgage market, using our internal database of market prices, yields, and nominal and OAS spreads which in turn provides a relative value framework for estimating overvalued and undervalued sectors and issues.
The risk management team develops risk budgets for each client portfolio. These risk budgets guide and monitor the allocation of a portfolio’s overall risk capacity across the range of available investment opportunities.
The QR&RM group utilizes a proprietary attribution and risk management system to perform detailed performance attribution and portfolio risk analysis. Both portfolio and risk managers receive daily online reports for each portfolio, highlighting where active risk is taken relative to the portfolio’s risk budget, including:
- Systematic Risk: Under most market conditions, returns associated with market risk factors tend to undergo small and independent day-to-day fluctuations, implying that mean and variance measures explain most of the distribution of returns. We seek to manage these risks daily via tracking error measures as well as principal component analysis. Systematic risk includes term structure risk, currency risk, and sector/quality risks.
- Tail Risk: Non-systematic or tail risks due to issuer, industry, and country exposures generally have skewed distributions. Because returns from these items, including instrument-specific returns, are not adequately described by mean and variance, we supplement tracking error measures with custom stress tests and risk thresholds to monitor and limit downside risk.
- Short Term Risk & Scenario Analysis: Short-term spread measures, based upon current market volatility, supplement long-term metrics of risk. In addition, portfolios are subject to multiple historical stress events from the Long Term Capital Management Crisis of the late 1990’s to the more recent Credit Crisis of 2008/2009.
The risk management team discusses potential risk issues with the portfolio managers and when appropriate, escalates these issues to the attention of the Chief Investment Officer, or ultimately, to the Head of Prudential Fixed Income.
The portfolio analysis team plays an integral role in each stage of the investment management process from pricing and monitoring data to portfolio analysis.
- Portfolio Analysis: An experienced analyst supports each trade desk and is the central point for portfolio-to-benchmark analysis, performance attribution analysis, and trade analysis for our portfolio managers. The portfolio analysis team is engaged throughout the full lifecycle of the portfolio: construction, asset allocation, rebalancing, risk adjustments, flow management, and unwinds.
- Pricing: The pricing team works with the major pricing vendors and each trade desk to ensure that all market related data used in our portfolios reflects current market conditions and is maintained at the highest quality standards. Over 20,000 securities are priced daily with the vast majority of securities receiving prices from multiple pricing services.
- Data Integrity: The data integrity team ensures that our security level data is maintained at the highest quality for our portfolio management, risk management, and modeling teams. Based on the team’s market expertise and utilizing a suite of automated data integrity checks to identify potential data issues, the data integrity team strives to ensure maximum data accuracy.