Improved Risk Reporting with Factor-Based Diversification Measures

Improved Risk Reporting with Factor-Based Diversification Measures — February 2014

Executive Summary

The Effective Number of Bets as a Useful New Risk Indicator Overall our analysis suggests that a better assessment of the degree of diversification of a portfolio in terms of its effective number of bets (ENB) would provide useful insights regarding the risk and return profile of the portfolio in various market conditions. The ENB measure appears to be a useful risk indicator not only across, but also within asset classes. In particular, we find statistical evidence of a positive time-series and cross-sectional relationship between this diversification measure and portfolio performance in bear markets. As such, it appears that the ENB measure could be a useful addition to the list of risk indicators for equity and policy portfolios, in addition to standard measures such as Value-at-Risk for example.

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An EDHEC-Risk Institute Publication