Potential Benefits of Multiple Risk Dimensions When Modeling Asset Returns

Benefits of Multifactor Models to Investors

Multifactor models help investors understand the comparative risk exposures of equity, fixed income, among other asset returns. This is done by performing a granular risk and return attribution on the actively managed portfolios.

Multifactor models help ensure that an investor’s aggregate portfolio meets active risk. Besides, multifactor models are critical in ensuring that an investor’s objectives correspond with active fees. This helps establish whether the investor’s aggregate portfolio meets their return expectations and risk appetite.

Multifactor models are instrumental in establishing exposures to various risk factors. This includes the risk factors that express specific macro expectations in portfolios such as inflation, economic growth, among others.

Question

Which of the following is the least likely benefit of the use of multifactor modeling of asset returns for investors?

1. It helps investors understand the comparative risk exposures of equity.
2. It helps in the construction of portfolios that obtain a consistent result on the characteristics of the benchmark.
3. It helps establish whether an investor’s aggregate portfolio meets his return expectations and risk appetite.

Solution

The correct answer is B.

It is not Investors’ duty to construct portfolios. This,is the work of passive managers.

A is incorrect. Multifactor models help investors understand the comparative risk exposures of equity, fixed income, among other asset returns. This is done by performing a granular risk and return attribution on the actively managed portfolios.

C is incorrect. Multifactor models help ensure that an investor’s aggregate portfolio meets active risk, and the return objectives correspond with active fees. This helps establish whether an investor’s aggregate portfolio meets their return expectations and risk appetite.

Reading 40: Using Multifactor Models

LOS 40 (g) Describe the potential benefits for investors in considering multiple risk dimensions when modeling asset returns.