Rev. Date December 9, 2020


What is a factor forecast?

A factor forecast reflects a view on the return for factors that is intended to be realized over a long investment horizon, such as 3+ years. As explained further below, you can use the historical geometric return forecasts provided by Venn or create custom forecasts using either your Capital Market Assumptions or a historical period in time.

What is the forecast volatility?

Venn calculates the annualized volatility using each factor’s returns over its full return history.

Where are forecasts used in Venn?

Forecasts are used throughout Venn. In particular, forecasts are a key input into Optimization[1] and the forecast metrics displayed in the Performance Summary section of various analyses.

How do forecasts affect Optimization?

Forecasts are fundamental to Optimization. Custom forecasts that reflect your future performance views on factors can help generate optimization results that are aligned with your organization’s views, while incorporating your specified objectives and constraints.

Default Forecasts

What are the Historical default forecasts?

Venn provides default return forecasts for each factor. The default forecasts are the geometric average calculated using the full period of historical returns available on Venn for each factor. These values tend to be relatively consistent over the long term.

Venn also provides a default return value for the risk-free rate using the average 3 month sovereign benchmark yield in the investor’s home currency over the last month.

Are the Historical default forecasts Two Sigma’s views of the future?

No. Importantly, the default forecasts do not represent Two Sigma’s views of the future. Rather, they are intended to provide a potential starting point for users to formulate their own forecasts.

How often are the Historical default forecasts populated?

Historical default forecasts are continuously updated with the latest available returns.

Creating Custom Forecasts

How can I change the forecasts to something other than the Historical forecasts?

You can create your own factor return forecasts by navigating to the Factor Forecasts modal and clicking on the “New Forecast” button at the bottom. This will then give you the option of creating a “Historical Forecast”, or a “CMA Forecast”.

  • For a Historical Forecast, select a time period that you would like your forecast to mirror. Venn will use this period to create a forecast of the geometric average returns and annualized volatility for each factor over the selected time period. Additionally, the factor correlations for the forecast will be calculated from the correlations between the factors over this time period.
  • For a CMA Forecast, enter your organization's Capital Market Assumptions for major asset classes. Select from various indices and assign geometric annualized expected return values to each. Venn will translate these views into forecasts for the factors in the Two Sigma Factor Lens. For best results, Venn suggests entering Capital Market Assumptions for at least 3 indices.

Once you are done entering your time period or Capital Market Assumptions, click the “Create” button at the bottom of the modal. Factors for which we were able to calculate forecasts using your inputs will be highlighted in purple. Any remaining factors for which we could not calculate a forecast will default to the Historical factor forecasts provided by Venn.

To make this forecast your organization’s default forecast, click the star icon in the top right of the modal. Note that this will change the default forecast for all members of your organization.

How can I access the Factor Forecasts modal?

The Factor Forecasts modal is accessible from the Performance Summary section of various analyses and from Optimization.

How does Venn translate my Capital Market Assumptions into factor return forecasts?

Venn first determines each of your selected index’s factor exposures over the past 3 years as well as their annualized residual return. Venn then computes the expected annualized factor returns by minimizing the difference between:

  1. The annualized expected returns you specified for each index - and -
  2. The specific index residual returns plus the sum of the factor exposures

Here’s an illustrative example: say you had a return expectation of 10% for Global Equity markets, as proxied by the MSCI World index. Venn determines that the MSCI World index has one statistically significant factor exposure of +0.9 to the Equity factor with a residual term of 1%. Venn will then seek to minimize the difference between 10% and 1% + (0.9*x), where x is the expected factor return for Equity based on your return expectation.

Will my Capital Market Assumptions translate to return forecasts for all of the factors in the Two Sigma Factor Lens?

Given the indices currently available in the Forecasts modal, your Capital Market Assumptions will not translate to all of the factors in the Two Sigma Factor Lens. To translate to a broad array of factor return forecasts, you will need to provide Capital Market Assumptions for a variety of indices that have statistically significant exposures to different factors, but it would be impossible to do so for each and every factor. In the illustrative example above, inputting a Capital Market Assumption for only Global Equity will likely not provide insight into your organization’s views on factors such as Local Inflation or Quality. Venn will use the Historical forecasts for factors that are not covered by your Capital Market Assumptions.

Do my Capital Market Assumptions impact forecast volatility?

No, your Capital Market Assumptions are used for return forecasts only. Other calculations, such as forecast volatility, will be based on the default Historical factor forecasts provided by Venn.

How do I save my forecasts?

Any time you create or update a forecast it will be saved, and accessible to all members of your organization.

Will I be notified if someone at my organization changes the forecasts?

You will not be notified if someone changes your organization’s forecasts, but can view your previously saved Forecasts and switch back if applicable.

What happens if my historical forecast period is less than a year?

If the selected period for your historical forecast is less than a year, the return and volatility will be annualized from this period. Factor correlations for this forecast will be calculated from the correlation between the factor returns during the selected period.

What happens if my historical forecast is from a period before a factor exists?

In this case, the return and volatility for any factor that does not have returns in the period of the forecast would be set to zero. These factors will also have zero correlation to the other factors in the forecast.

Residual Forecasts

How do I override a residual forecast?

You can override the forecasted residual return for an investment by navigating to the Factor Forecasts modal, clicking on the “Residual Forecasts” tab, and clicking on the “New Residual Forecast” button at the bottom. Search for and select the investment for which you wish to enter an override. Enter your own residual forecast to override the default.

What determines an investment’s default residual forecast?

An investment’s default residual forecast is determined by its most recent residual period (either last 3 years or last 12 months, depending on data availability and frequency).

[1] Please note, this feature is only available in certain jurisdictions.

This document highlights certain aspects of this analytic. As an overview, it does not discuss all material facts or assumptions. Please see Important Disclosure and Disclaimer Information.

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