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An Integrated View of Risk and Return

There are two widely used paradigms for analyzing risk and return: one where each security is modeled with the highest level of specificity possible, and another where a small number of common, fundamental factors are extracted from the security-level returns. The two approaches are complementary and it is important that they coexist within a unified underlying framework. For example, it is common that a risk manager will use the security-level approach to monitor position-level limits, while a portfolio manager will use fundamental factors to create portfolios that express views on market themes. A unified framework ensures that risk limits are communicated effectively from middle to front-office, and that nothing gets “lost in translation”.
This document introduces the two approaches and illustrates how they can be combined effectively across different investment management functions.