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Would IBM Watson Invest in Greece and China?

IBM Watson famously used data and analysis to disrupt the Jeopardy industry. Here at Cassia we use advanced data-driven methods to do a better job at managing money.

No sensationalism. Just numbers.

The recent market turbulence produced maximum losses of -37% in Chinese equities, -20% in EM equities, and -9% in International equities. US equities was king, suffering only a -4% loss during the same period. Naturally, you may be wondering: what was Cassia’s advanced risk management system saying during this period?

But first, how exposed are investors in general to these markets? Huge, it turns out. Take the leader in the online robo-advisor space, for example.

Wealthfront allocation

Emerging Market Equities 31%
International Equities 18%
US Equities 20%
US REITs 16%
US Income Equities 5%
US Corporate Bonds 5%
Emerging Market Bonds 5%

Wealthfront’s aggressive portfolio has about 50% invested between international equities and emerging markets. In comparison, here is what Cassia’s portfolios are invested in.

Cassia Optimal Premia+ allocation

US Equities – Buyback Index 85%
US 20+ Yr Treasury 15%

Cassia’s Optimal Premia allocation

US Equities – Buyback Index 39%
US 20+ Yr Treasury 28%
US High-yield Muni 16%
US Equities – Min Vol 11%
US Aggregate Muni 4%

Cassia has ZERO exposure to international and emerging equities. By avoiding these troubled equities markets, Cassia’s portfolios avoided what could’ve been much higher losses in June.

How does Cassia’s managed programs know to avoid the troubled markets?

These risks were completely avoidable ahead of time

Linking back to our previous month’s research on options. The collective wisdom of options traders were already anticipating significant risks 2 months before the Grexit vote. The term structure of the options contracts on European equities was negative for much of May and June. Recall that a negative/flat term structure predicts lower returns over the next month. Here’s what the inverted term structure looked like.

inverted-volatility-term-structure

Even without the help of the options markets, advanced risk forecasting models such as Cassia’s own multivariate GARCH were seeing the same thing. Once again, exposure to EM and International equities was completely avoidable ahead of time.

Here’s our forecast on June 1st, before the Greek/China crash.

Cassia’s Volatility forecast Cassia’s Return forecast Return/Volatility
EM Equity 19.30% -0.80% -0.04
Int’l Equity 16.80% 5.80% 0.35
US Equity (S&P 500) 13.40% 14.90% 1.11
US Equity (Buyback) 13.20% 17.80% 1.35

Cassia’s forecast models pegged EM and Int’l Equities at higher risk AND much lower return! From this it’s clear why Cassia’s programs are heavily invested in the US Buyback index instead of the other markets.

What about during and after the Greek/China crash? Here’s our forecast on July 1.

Cassia’s Volatility forecast Cassia’s Return forecast Return/Volatility
EM Equity 20.50% -1.80% -0.04
Int’l Equity 17.10% 4.50% 0.26
US Equity (S&P 500) 13.50% 13.70% 1.01
US Equity (Buyback) 13.20% 16.80% 1.27

Cassia’s risk model does not see contagion between these markets. The model has kept its volatility forecast of US equities the same as the previous month, while upgrading the volatility of EM and International equities.

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Build your practice on the backs of 3 Nobel prizes — Prospect Theory, MPT, and GARCH. 

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See what GARCH can do for you.
Build your practice on the backs of 3 Nobel prizes — Prospect Theory, MPT, and GARCH.