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Research Insight - Manager Risk Contribution: Attributing Risk in a Multi-Manager Portfolio

MSCI extends the analysis of a previous paper, Benchmark Misfit Risk: Identifying the Risk Contribution Arising from Differences in Manager and Policy Benchmarks, where we introduced the misfit effect on a Global Equity portfolio. In this latest paper, the same Global Equity portfolio is formed from the combination of five managers across three regions. We form an expression for Manager Risk Contribution in terms of the selection effect and misfit effect. We use this expression to calculate the Manager Risk Contribution for each of the managers.

The result is a decomposition, which identifies the contribution to the active risk of the Global Equity portfolio from the following sources for each of the three regions: allocation, selection and benchmark misfit. For each manager k in each region i, we identify the manager risk contribution. Finally, we demonstrate that the traditional Brinson allocation effect can be added to the sum of the manager risk contribution across region i to measure the risk contributed for the region as a whole.

MSCI believes the results described are significant because they facilitate a coherent view of a manager's portfolio: the Manager Risk Contribution is a simple function of the Manager Risk. This should have meaningful implications for the reporting framework used by investors to attribute ex-post performance (return, risk and risk-adjusted return), as well as ex-ante risk. Moreover, though we discuss risk as the standard deviation of benchmark relative returns here, this framework is applicable to any convex risk measure such as expected shortfall.