Rev. Date December 11, 2023
What is the purpose of Scenario Analysis?
Scenario Analysis was designed to help subscribers estimate how portfolios and investments could react to certain market shocks.
Which scenarios are available?
Scenario Analysis allows users to shock market indices to stress test portfolios and investments across various types of scenarios, such as:
Equity market performance. For example, estimate what could happen to a portfolio or investment if certain equity indices decline by a specified amount.
Emerging currency changes. For example, estimate what could happen to a portfolio or investment if emerging currencies lose a specific amount.
How do I create a new scenario?
Scenario Analysis comes pre-populated with several scenarios. A user can add a new scenario by clicking “Add another scenario…,” searching among the available market indices, and entering the size of the market shock in the “Scenario Return” column. The pre-populated scenarios can be removed by clicking the trash can icon on the left of the Scenario Index column.
In order to change an existing scenario, simply change the value in the Scenario Return column, and the Estimated Return of the portfolio or investment will update.
What is the time horizon for the scenarios?
Scenario Analysis assumes the shock will occur over the next 30 days.
What is the shock range available for Scenario Analysis?
Shocks are limited to 150% of the most extreme historical positive and negative returns observed for that index.
What is the Estimated Return?
The Estimated Return is the estimated return of the portfolio or investment over the next 30 days, under the specified scenario. This number is an estimate only and carries many uncertainties such as noise in estimating the portfolio’s or investment’s factor exposures. The error bands attempt to quantify this uncertainty.
Users can also hover over the estimated returns to see the factor contributions to estimated performance.
Generally, how is the Estimated Return calculated?
Venn calculates the sensitivity of the scenario index’s returns as well as the portfolio’s or investment’s returns to the factors in the Two Sigma Factor Lens. By translating each return into the shared language of factor exposures, Venn can then estimate how a shock to one (here, the scenario index) would affect the other (the portfolio or investment).
Further, Venn uses two different methodologies depending on the size of the scenario index shock:
For shocks less than 2 standard deviations, a linear approach, which does not model changing market conditions, is used.
For shocks between 2 and 3 standard deviations, the two methodologies are blended.
For shocks greater than 3 standard deviations, a regime-based methodology is used.
What returns are used to determine the portfolio’s or investment’s factor exposures?
The portfolio’s or investment’s factor exposures are calculated using at least the last 6 months of daily data or 1 year of monthly data for the portfolio or investment.[1]
How does Venn handle the portfolio’s or investment’s residual return?
Scenario Analysis explicitly measures the scenario’s impact on the portfolio’s or investment’s residual return. Venn breaks down the index shock into implied factors and the index’s residual movements. The portfolio’s or investment’s returns are regressed with respect to both the factors and the scenario residual to obtain the exposures to them. The total portfolio’s or investment’s residual contribution to estimated return consists of the return contribution from the scenario residual and the portfolio’s or investment’s regression residual.
If I add multiple scenarios, does Venn calculate their impact on the investment’s or portfolio’s return in aggregate?
Currently, each scenario is calculated independently of each other. For example, if your Scenario Analysis includes an equity market index shock and a commodity index, each row will represent the estimated effects of each shock on the portfolio or investment, not as if both were to occur at the same time.
Does the index I shock change what factors are being used to model the impact?
For each independent shock scenario, Venn is modeling the impact of the index movement across all factors in the Two Sigma Factor Lens, regardless of which index is being used on which investment or portfolio. For example, shocking a commodity index could impact Equity, Interest Rates, etc., not just the Commodities factor. Users can hover over the estimated returns to see which factors are driving estimated performance.
[1] The minimum amount of data required depends on data frequency and type of analysis. For Scenario Analysis, if a user’s portfolio or investment has daily data, Venn will require at least 6 months, or if monthly it will require at least 1 year. For both daily and monthly data, Venn will prefer to use up to 3 years. For quarterly data, Venn requires 3 years (or 12 data points) but will prefer to use up to 9 years to run analysis. Portfolios or investments with quarterly data must be interpolated to perform Scenario Analysis.
This document highlights certain aspects of this feature. As an overview, it does not discuss all material facts or assumptions. Please see Important Disclosure and Disclaimer Information.