Causeway Capital Commentary- Risky Business: Causeway Risk Lens Turns 5

Sometimes you gotta say, What the [heck], make your move.' - Miles Dalby, Risky Business

Five years ago, Causeway made its moveoffering online access to its proprietary risk model. The cloud application, called Risk Lens, is free for institutional investors and advisers. We asked Causeway's co-founder, Sarah Ketterer (Trades, Portfolio), portfolio manager, Joe Gubler, and Risk Lens COO, Turner Swan, for their perspectives after five years online.

Joe, what problem does Risk Lens address?

JG: Initially, we had an internal problem. Causeway manages institutional client portfolios fusing fundamental and quantitative analysis, and one of our tenets is that risk matters. You cannot just look at performance, but risk and returns are inextricably linked and returns are ultimately the compensation for accepting uncertainty. We risk-manage our strategies carefully and constantly monitor portfolios with our proprietary risk model. The risk model, designed by our portfolio managers, is multi-factor and basically derives expected stock returns after assessing predicted risk exposures. It was and is a powerful tool for analyzing Causeway's managed portfolios.

The problem, though, was that we wanted to use the same predicted risk analysis to compare our portfolios to other managers. This would help us better assess Causeway versus peers and help us manage portfolios and communicate portfolio positioning more effectively with clients. But the risk model did not have access to other managers' portfolio holdings.

SHK: To fix this, we designed Risk Lens to apply elements of our risk model to other managers' portfolios, as well as our own portfolios. We obtained the portfolio data by accessing the latest publicly available holdings of equity mutual funds, and back in 2013 we created the initial version of Risk Lens on manual Excel spreadsheets for internal use and to show clients.

As time went on, we realized that other institutional investors and fiduciaries had the same problem. They needed to know the key predicted risk exposures of their portfolios, and they needed to be able to compare these metrics to other managers.

JG: That's when we realized we could share our risk model, through Risk Lens, directly with clients and other institutional investors. So in 2019 we made our move and provided independent online access to a broad institutional universe. Now Risk Lens is our proprietary analytics tool that provides key equity portfolio risks, predicted active return correlations (PARCs), ESG scores, and fund screening. It's in the cloud and users can get access through their mobile devices or anywhere they have an internet connection. We want our clients and the adviser community to have easy frictionless access via the cloud, so Risk Lens is free to use and requires no subscription agreement.

TS: For key risks, the tool analyzes the current holdings of a portfolio and shows predicted risk exposures and how much they contribute to tracking error. Among others, we show predicted volatility, predicted beta, predicted tracking error, and more. Risk Lens also provides style exposures, ESG scores, diversification ratios, active share, and geographic, sector, currency and market cap exposures. We like to emphasize, know your portfolio. Risk Lens helps a user look deep into a portfolio and when we look at risks, we are looking at recent holdings and generating predicted risks. This helps asset managers align predicted equity portfolio risk with their clients' risk levels.

Joe, what does the Risk Lens output look like?

JG: Figure 1 is an example of a single fund summary, with a pie chart showing top risk allocations, and also predicted tracking error, volatility, and beta. At a given point in time, funds will have distinctive risk footprints and Figure 2 is an example of a style risk footprint. The graph is part of a comparative fund analysis report that shows active style exposures based on current portfolio holdings of four compared funds. At a glance, you can see the funds with more (blue) or less (gray) exposure to a style factor than the benchmark. To calculate style exposures, securities are z-scored on each of the eight style dimensions. The standardized z-scores range from +3 to -3, with a score of 0 being equal to the weighted average score across the universe, +3 being most representative of the style, and -3 being least representative of the style. Fund style exposures are the weighted average of the style scores of fund holdings. Active style exposures measure the difference between fund style exposures and benchmark style exposures.

Turner, why does Causeway offer Risk Lens and who uses it?

TS: As Sarah noted, Risk Lens is first and foremost a tool for our clients, and we see Risk Lens as a way to further partner with clients. It offers users direct access to our proprietary risk model to analyze their own portfolios, as well as the thousands of equity funds in Risk Lens' universe. In addition to client service, Causeway will provide Risk Lens analysis to certain prospective clients so they can use Risk Lens themselves to evaluate and compare competitors in manager searches. We also believe Risk Lens showcases Causeway's risk management prowess and generally helps promote Causeway's brand to a broad institutional universe.

JG: As a portfolio manager, before going into a search presentation, I typically run Risk Lens comparing our Causeway strategy to competitors. If we don't know our specific competitors, I'll use Fund Screener in Risk Lens to screen the relevant benchmark universe and show the range of risk characteristics and top performers to help us understand how Causeway compares to peers. I'll also often use our predicted active return correlation (PARC) tool to review the predicted correlations of a group of funds with Causeway funds, or to show a single fund's top complementary (low correlated) and substitute (high correlated) funds. Using Risk Lens helps me have more sophisticated conversations with clients about the portfolio we manage and how it compares and contrasts with other equity funds.

TS: Our top users include analysts at some of the largest asset management firms in the world, and most of our users are also clients or have clients invested with Causeway.

Usage is growing. Since 2021, the number of external users has increased 136% and the number of external Risk Lens reports generated has grown 631%. We are pleased so far with the attention Risk Lens has generated. We also survey top users from time to time and add features based on their input.

Joe, how can asset managers avoid investing in funds that are too similar?

JG: In 2013, we developed the calculation of predicted active return correlation, which we like to call PARC for short. PARC forecasts correlations between two or more funds, and is exclusively available in Risk Lens. This can help a manager avoid investing in funds that are too similar and help ensure diversification. It also shows if substitute funds used to replace funds for tax loss harvesting, high fees, etc. are predicted to be highly correlated, as shown in Figure 3.

We calculate funds' historical returns to their style, country, sector and currency exposures to forecast correlations from 1 to +1, ranging from exact opposite correlation to no correlation to exact correlation. Users can use PARC to identify top complementary and substitute funds for asset allocation, as shown in Figure 4.

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This article first appeared on GuruFocus.