Recently, Harindra de Silva, Ph.D., CFA, Portfolio Manager for the Wells Fargo Asset Management Analytic Investors team and sub-advisor to our long/short equity strategies was a guest on the podcast, On the Trading Desk® with Laurie King to talk about how a new factor, namely the stay-at-home order, has changed historical risk profiles and what it may mean for a portfolio’s risk profile.
Below is a transcript of the podcast or you can listen to the podcast here.
Laurie King: Factor investing has some important lessons for us as it relates to how risk has changed in the marketplace. I’m Laurie King and you are listening to On the Trading Desk®. Today I’ll be talking with Harin de Silva, Portfolio Manager for the Wells Fargo Asset Management Analytic Investors team about factor investing, and that’s what Harin and the team at Analytic Investors are experts at and have been doing for 30 years. Their models, which adapt to current conditions and deliver up-to-date snapshots of the risk environment, provide us with important and timely information to consider when making investment decisions. Welcome to the program, Harin.
Harin de Silva: Thank you for having me, Laurie.
Laurie: Your team recently wrote a piece called, The betas, they are changing… So let’s get right to the heart of it. How does factor investing help you see a changing pattern for risk, and why should this matter to our listeners?
Harin: So a factor is basically a way to measure whether something is explaining volatility or risk in the market or not. So for example, if you think about equity markets, often people use a measure of risk like beta to measure how sensitive a stock is the overall price movements. And just like beta, there are other factors that matter, for example, things like oil prices.
And what we’ve seen recently is a really dramatic shift in what types of factors are being rewarded in the marketplace. So for example, when you think about house prices, what matters in terms of pricing a house is the number of bedrooms, the square footage, and so on. So in the 70s and 80s and even now, those are very important factors, but a factor that came into importance more recently, maybe the last couple decades or so, is the presence of lead paint in the house. So just like lead paint became important for houses more recently, what I would call the “stay-at-home” factor has become very important for equity investing because there are certain businesses that extremely susceptible to consumers staying at home.
So for example, if you take something in the consumer services sector, which is basically hospitality, restaurants, hotels, that sector is very sensitive to whether the employees are able to come to work and, more importantly, whether the customers are actually able to visit them. So they’re very sensitive to a mandate by the government that requires all consumers to stay at home. Whereas, if you look at the food industry or the food production industry, that is not very sensitive to the stay-at-home factor.
So this new factor is really something that has come into the fore recently, and we see that in the way industries are behaving and the way companies are behaving.
Laurie: So I hear you saying that it’s a dynamic situation because of the coronavirus pandemic, which means that risk assessment is more important than ever.
Harin: It is. The challenge with risk is it’s constantly migrating from one portion of the marketplace to another sector of the marketplace, right? So if you’re not constantly assessing the risk, you may miss this new risk that’s shown up.
Laurie: And to assess risk, I know that you look at risk forecasts by country, by industry, and by stocks themselves. So how is this new factor affecting each of those?
Harin: It’s actually very interesting, because when you look at the change in risk over the last two or three months, what you see is that the risk of countries has changed very little. So the impact of what I’m calling the stay-at-home factor has actually been the same regardless of whether we’re looking at developed markets or emerging markets, whether we’re looking at Europe or Asia. So the risk has been almost country agnostic.
It’s not true for looking at industries. So certain industries like real estate, hospitality, the conference industry, those have been really negatively affected, so the risk of those industries has dramatically gone up.
Other industries, for example, computer hardware, has surprising seen their risk come down because it’s become increasingly evident that people are using technology almost as utility. So surprisingly, you’ve seen the risk of the industry come down.
And then if you look at within stocks, you’ve seen some pretty dramatic changes, as well.
Laurie: Can you share an example of what this new risk factor may mean at the stock level?
Harin: Sure. So if you take an industry like entertainment, for example, you would expect that entertainment companies would be relatively unaffected by the stay-at-home factor, right? The majority of the world has access to phones to watch video at home, so you would think entertainment would be impervious to this type of change.
But surprisingly, if you look at stocks within the industry, you see some pretty dramatic changes. In a company like Netflix, which basically survives primarily on streaming services, the beta of the company has dropped dramatically in this time period, so it’s become less risky because it’s less susceptible to the stay-at-home risk, where a company like Disney where they draw revenue not only from streaming services, but also from hotels as well as theme parks, their risk is dramatically gone up.
So even within one industry based on where a company’s revenue’s coming from, the risk of the stock has changed dramatically. So it’s a really good example for why you need to evaluate the risk of your portfolio in the light of this dramatic change that’s taken place in the market.
Laurie: So as we wrap up this episode of On the Trading Desk, do you have a takeaway message that you’d like to leave our listeners with?
Harin: Yes, I would say this is the time at which it’s really important to evaluate the holdings from a perspective of how the risk profile of companies has changed.
If you look at the risk profile of a company of an industry, it generally doesn’t change much from month to month, but over the last three months, you’ve seen a change that you haven’t seen in the last 20 years. Even when we went through the credit crisis, when we went through the tech bubble, you never saw such a big revision in the riskiness of a company change.
So it’s really important to look at your holdings, look at your portfolios, and get a sense for are you carrying more risk in your portfolio than you think you are because the risk profile of the company has changed in a way that’s been a surprise.
Laurie: Thank you for putting that into perspective for us and thanks for joining us today, Harin.
Harin: Appreciate you having me, Laurie. Thank you
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