Bloomberg User Manual

School of Economics and Finance

Faculty of Business and Economics
University of Hong Kong

Chapter 5
Portfolio and Risk Analysis

Copyright © 2013 by School of Economics and Finance, University of Hong

Kong

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Chapter 5 Portfolio & Risk Analysis
Overview
Bloomberg offers a comprehensive solution in portfolio analysis including portfolio maintenance,
performance and attribution as well as risk analysis to meet the needs of today’s global asset
managers. In this chapter, we will introduce Bloomberg Portfolio & Risk tools in detail and
explain the rationale behind to give you a thorough understanding of it.

We will start with portfolio maintenance tools to show you how to upload a portfolio into the
system and how to change its position, followed by performance analysis such as characteristics,
attribution and real-time monitoring. Lastly, we will introduce risk analysis including Bloomberg
proprietary risk factor model.

5.1 Portfolio Creation and Maintenance

Holding-Based Portfolio System: before you start to create/upload a portfolio in the system, you
need to know that the portfolio system in Bloomberg is holding-based, not transaction-based,
which means you need to let the system know what you hold but not the transaction you have
done. Therefore, you are required to update your latest position whenever there are any changes.
A numerical example will be shown later to illustrate the concept.

Before analyzing your portfolio, you may need to create a portfolio in Bloomberg. There are two
ways to create/upload a portfolio into the system. Both will be introduced in this section and you
may choose either one depending on your portfolio nature and your preference. The functions
that will be introduced are as follows:

Function Code Function Name

PRTU<GO> Portfolio Creation and Update
PBEN<GO> Portfolio Custom Benchmarks
BBU<GO> Bloomberg Portfolio Uploader

PRTU<GO>, Portfolio Creation and Update, allows you to create a new portfolio and update
your latest position in an existing portfolio. You may click 1) Create at the top left red bar to
create a new portfolio after running PRTU<GO>. In the setup window, you can specify the
parameters for your portfolio such as position type, benchmark, asset class and etc. (see Figure
5.1). Let us explain the important parameters one by one and use an example to illustrate them.

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 Figure 5.1 Portfolio Setup page in PRTU<GO>

Position Type: Shares / Par Amount allows you to enter the amount of shares that you hold for
each security in the portfolio; Fixed Weight allows you to specify a fixed weight for each
security in the portfolio and when the prices of securities change, the amount of shares will
change accordingly to maintain the fixed weight (also known as constant-mix strategy). Drifting
Weight allows you to specify an initial weight for each security and the weights will be changed
proportionally with the daily market price change of the securities. A higher (lower) weight will
be assigned when the price of the security increases (decreases).

Benchmark: you can specify a default benchmark for your portfolio if applicable. Bloomberg
allows you to customize benchmark. To do so, please go to the Benchmarks option in the left
sidebar in PRTU<GO> (equivalent to PBEN<GO>) and click 1) Create to either create a
custom benchmark by entering individual stocks like creating portfolio or link to a source such
as another portfolio (see Figure 5.2).

Figure 5.2 Portfolio Custom Benchmarks: PBEN<GO>

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Portfolio Currency: you may specify the currency for your portfolio especially if there are
different trading currencies for securities in your portfolio.

Asset Class: you may specify the asset class for your portfolio, i.e. equity, fixed income,
balanced or fund of funds. Wrong asset class may cause error for some analysis. In this chapter,
we will only focus on equity portfolios.

Enable History: by ticking the box Enabling History, you will be able to enter the positions of
your portfolio in the historical dates, otherwise the position entered when you create a portfolio
are as of today without any history and you have to wait for sufficient data points before running
analysis like historical return. Enable data acquisition allows you to run attribution analysis such
as assets allocation effect. Include cash applies to the scenario with futures contracts and short
sell positions in your portfolio where a margin is required. You can choose either cash or
percentage.

Let us use an example to demonstrate how to use PRTU<GO> to create a portfolio. Suppose
you would like to create an equity portfolio called US Large Cap and the initial position on June
1, 2011 are:

Ticker No. of Shares

AAPL US 50,000
GOOG US 40,000
WMT US 30,000
JPM US 20,000
PFE US 10,000
PG US 5,000
On June 1, 2012, you sold 1,000 shares of P&G (PG US) and bought another 5,000 shares of
Apple (AAPL US).

After specifying the setup page as Figure 5.3, you may click 1) Create at the bottom to continue.

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 Figure 5.3 Example Portfolio Setup page in PRTU<GO>

In the position setup page as Figure 5.4, you may need to change the date to 06/01/11 first at the
top so that you can enter the initial positions of your portfolio on that day. You can either
manually enter the tickers and the number of shares in the Security and Position columns
respectively, or drag and drop from Excel as shown in Figure 5.4 (highlight the columns for
tickers and shares and move the mouse to the edge of the highlighted area to drag). Click 1) Save
before entering positions for another day.

Specify purchasing price here if you want

Remember to change the date first!
(optional). However, the portfolio return in
Bloomberg is calculated based on the closing
price only and cannot be customized. Cost
price only applies to the cost-based intraday
P&L analysis which will be introduced in 5.2
Portfolio Return Analysis.

The price under Current is

the closing price as of that
day for each security

Figure 5.4 Position setup as of 06/01/2011 in PRTU<GO>

From June 2 2012 to May 31, 2012, no transactions happened and thus the positions remained
unchanged and you do not need to enter the same position for each day. On June 1, 2012, the
shares of Apple that you held became 55,000 and shares of P&G became 4,000 after the
transactions that you have made. You may need to change to 06/01/2012 at the top of the page
and enter the new position that you held as shown in Figure 5.5. Click 1) Save afterwards.

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 Remember to change the date first! Remember that the portfolio system in
Bloomberg is holding-based and you
need to specify the amount of securities
that you hold but not the transaction
once the positions changed.

Figure 5.5 Position setup as of 06/01/2012 in PRTU<GO>

The example portfolio has been set up and can be found from the portfolio list in PRTU<GO>.
It reflects that you started to hold the initial position from June 1, 2011 until May 31, 2012 and
changed to another position (bought 5,000 shares of Apple and sold 1,000 shares of P&G) on
June 1, 2012 and such position has been held until now. Remember that once the position is
changed, enter the latest position on the corresponding date. For short sell position, you may
simply put a negative sign in front of the amount in the Position column.

BBU<GO>, Bloomberg Portfolio Uploader, is another method to create and maintain portfolio
in Bloomberg which allows you to upload portfolio from xls, xlsx, csv or ASCII text files. You
are also allowed to upload multiple portfolios and positions on multiple dates at one time.
Scheduled uploads are enabled to save your time if applicable.

Let us use Excel with the same example for PRTU<GO> to demonstrate how to do it via
BBU<GO>. You may need to create an Excel file first with necessary columns to upload your
portfolio (see Figure 5.6) and we will explain the columns one by one.

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 Figure 5.6 Excel file for uploading portfolio via BBU<GO>

Portfolio Name: it is not mandatory unless you need to upload multiple portfolios in the same
sheet. For single portfolio uploading, the system will use the file name as the portfolio name if it
is not specified in the file. We use US Large Cap BBU here as an example which will be the
portfolio name after it is created.

Security ID: it is mandatory and tells the system the securities in your portfolio. It can be
Bloomberg ticker (in our example), CUSIP or ISIN.

Position: it is mandatory as well to reflect the position of each security in your portfolio. It could
be share amount or weight. Again, you can enter a negative amount for short sell position.

Date: it is mandatory if you need to upload a historical position like our example. You can enter
multiple dates with the corresponding holdings on each date as shown in Figure 5.6. If no date is
specified, the position uploaded will be as of today.

If you would like to upload cash position, you can enter Bloomberg ticker such as AUD Curncy
in the Security ID column.

After the file is being saved, you may run BBU<GO> and select the file from the local disc and
upload. For other types of portfolio which are not covered here, you can go to 3) Additional Info
at the top red bar and select Sample Files from the drop-down menu to download the sample files
such as long short portfolio and try to upload following the instruction shown below.

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 System will process
the file after clicking
4) Upload and once
it is uploaded
successfully
(showing Click to
Map in the Status
column), you may
click it to continue

Figure 5.7 Bloomberg Portfolio Uploader: BBU<GO>

In the next step, you may select the correct worksheet of the Excel file and click 1) Next at the
bottom to proceed to the next step.

BBU<GO> can
detect all the
worksheets in
the file and it is
not mandatory
to keep data in
Sheet 1.

Figure 5.8 Spreadsheet Selection step in BBU<GO>

In step 3, you may need to specify the data that you would like to upload. In our example, the
first row of the file is for titles and does not contain any portfolio data. Therefore, you may enter
2 in the amber box of Start Upload at line to start from row 2.

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If you have uploaded
a portfolio via
BBU<GO> before
and this portfolio
upload sheet follows
the same format, you
can apply the
previous portfolio
mapping for this one.

Figure 5.9 Choose Delimiters step in BBU<GO>

In the next step, you may need to select the correct columns for the portfolio data as shown in
Figure 5.10 to map your file and the system for portfolio creation. The Skip Column option in
the list allows you to skip the columns that you do not want to upload into the system to give you
flexibility of your Excel file.

From this step, you can

see that the title names in
your file could also be
customized as long as you
are able to match the data
in each column with the
tile in BBU<GO>

Figure 5.10 Map columns step in BBU<GO>

If there is any security that cannot be identified by the system, it will be shown in the step of
Security Mappings and you may need to replace it with an identifiable ticker.

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 Figure 5.11 Security Mappings step in BBU<GO>

In the last step, you may need to set portfolio parameters such as currency, asset class and date
format. Click 2) Finish at the bottom after all the parameters have been set up. The status will
change to Completed and you will be able to view the portfolio in the list of PRTU<GO>.

Figure 5.12 File and Portfolio Defaults step in BBU<GO>

BBU<GO> also supports scheduled uploads which only requires you to update the Excel file
and the latest positions will be uploaded as scheduled. You are required to log in the system for
scheduled uploads which may restrict the usage in the Bloomberg Lab and we are not going to
introduce it in detail.

You may also take a look at DOCS 2050932<GO> for a guide of how to upload portfolio via
BBU<GO> if you would like to know more about it.

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5.2 Portfolio Performance Analysis
Bloomberg Portfolio & Risk Analytics PORT<GO> has integrated all different kinds of
portfolio analysis into one platform to provide great discoverability and consistent methodology
across all the return and risk analysis. PORT<GO> supports analysis of both equity and fixed
income portfolios and we will only introduce the analysis for equity portfolio mainly using the
portfolio US Large Cap that we uploaded in section 5.1 Portfolio Creation and Maintenance.

5.2.1 Basic Setting of PORT<GO>

There are 8 primary data tabs and 28 additional sub-tabs. Each tab is fully customizable to
display the data that you are interested in. Charting capabilities including heat maps and scatter
plots are incorporated to provide a visual presentation.

Primary Data Tabs

Sub-tabs

Click to view the

heat map and
other charts

Figure 5.13 Portfolio & Risk Analytics: PORT<GO>

In this section, we will introduce 5 primary data tabs: Intraday, Holdings, Characteristics,
Performance and Attribution. The remaining 3 tabs will be introduced in section 5.3 Portfolio
Risk Analysis. We will introduce basic settings in PORT<GO> before starting any tabs.

After running PORT<GO>, you may select the portfolio to analyze first by clicking the icon
next to the amber box of Port (see Figure 5.14). You may set default portfolio by clicking the
box of the Def column. The Fav column allows you to select portfolios that you will analyze in
PORT<GO> quite frequently as favorite portfolios so that you can select from the list in the
drop-down menu of the Port amber box.

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The amber box of Breakdown by allows you to group the securities in the portfolio by sector (up
to 4 levels grouping), region, credit rating or even custom model that you create in PCLS<GO>
(we will introduce later in this section).

To view the definition of a column, you may move the mouse to that column and the definition
box will pop up. To rank data by a column, you may left click the column. To add, remove or
change the order of columns, you may right click the column.

Change the date to view

the historical information

Click to view news

related to your
holdings

Right click to add/remove

columns; left click to rank
by the column data

Change the font size

Figure 5.14 PORT<GO> navigation

To change the default settings of PORT<GO>, you may click 11) View to create a new view or
edit the current view. For example, by clicking Edit Current View…, you will see a screen like
Figure 5.15 where you can set general settings, portfolio and grouping, tabs and columns and
calculation grouped in the sidebar at the left. For example, Tab Order allows you to add, remove
or change the order of the primary data tabs.

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 The 5 tabs that will
be introduced in this
section have been
moved up together

Figure 5.15 Default Setting in PORT<GO>

The options under Tabs & Columns allow you to customize the columns in each tab. You may
view all available fields from the list under Available Fields and click once to add it into the
selected fields in the main view of tab. After selecting a field in the selected fields list, you may
move it up or down or set its default like decimal below (see Figure 5.16).

Selected Fields

Click to see definition

Figure 5.16 Tabs & Columns default setting in PORT<GO>

To create a custom grouping model that can be used in PORT<GO>, you may go to Portfolio
Classifications PCLS<GO> (equivalent to PRTU<GO> -> 2) Actions -> Classifications
(PCLS)). Click 1) Create at the top left red bar to start. There are 4 types of classifications for
you to choose from the amber box Type with explanations as shown below (see Figure 5.17).

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 Figure 5.17 Portfolio Classifications: PCLS<GO>

Let us create a custom model named Universities as an example with different universities
holding different securities as follows:

University Security Held

HKU AAPL US
HKU GOOG US
HKUST WMT US
HKUST JPM US
CU PFE US
CU PG US

In this case, we may use Security Buckets as type which allows you to create groupings based on
a list of securities. Click 1) Create to go to the Classification Tree page where you can click 10)
Add to create node names for different universities (see Figure 5.18).

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 Figure 5.18 Classification Tree page in PCLS<GO>

After creating nodes for different universities, you may specify the securities that each university
holds (see Figure 5.19) and click 1) Save to finish.

Figure 5.19 Specifying securities in PCLS<GO>

With the custom grouping model created, you can apply it in the PORT<GO> page to see the
breakdown by the model that you have created (see Figure 5.20).

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 Click this icon to load the custom
grouping model into the list

Figure 5.20 Custom Grouping Model in PORT<GO>

5.2.2 Portfolio Intraday Monitoring

The Intraday tab in PORT<GO> allows you to track the intraday performance (real-time) of
your portfolio against benchmarks that you choose including intraday P&L, total return and
contribution to return (CTR) at portfolio, sector and security levels.

Click the boxes to show the field for

the benchmark and the different
between portfolio and benchmark

Real-time monitoring
in chart and change
field as you like
Right click any column to show this box

Figure 5.21 the Intraday tab in PORT<GO>

You can select a benchmark from the top amber box of Bmrk to compare the intraday
performance of the portfolio with the benchmark and right click any column to customize
columns as you like. The fields under Cost-Based Return calculate the return and P&L based on
the cost prices of each securities that you specified in PRTU<GO> under the Cost column (see

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Figure 5.4). The tab also has intraday attribution fields available now to help you understand
which factor contributes to your return (asset allocation, security selection or currency). We will
introduce attribution analysis in detail in section 5.2.6 Portfolio Attribution Analysis.

The Top Holding sub-tab displays the top and bottom holding securities contributing to the
intraday return as well as the largest positions that may affect your intraday return significantly.

Figure 5.22 the Top Holding sub-tab under Intraday

5.2.3 Portfolio Holding Analysis

The Holding tab in PORT<GO> provides a basic view of current positions, weights and
allocations across sector, country or any custom grouping model of your portfolio.

Tick it to view the

holding trends
within a date range
in both table and
graph views

Figure 5.23 the Holdings tab in PORT<GO>

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You can choose a date in the amber box at the top right to view your holdings as of a specific
date as well as comparison with benchmark in both table and graph views. You can also tick
Trend at the top and select a date range to see the holding trends in sector and security levels.

The Allocation Summary sub-tab displays the holding breakdown by sector, top/bottom 10
holdings and a graphical comparison with benchmark to give you an overview of your portfolio
sector allocation information.

Choose the display

data as you want:
Combined shows
the sector weights
of both portfolio
and benchmark

Figure 5.24 the Allocation Summary sub-tab under Holdings

5.2.4 Portfolio Fundamental Characteristics

The Characteristics tab allows you to analyze the fundamental characteristics of your portfolio
such as P/E, Dividend Yield and Earning Growth as of a specific date or as a time series trend.
Portfolio fundamentals are
calculated using index method, i.e.
P/E = Total Portfolio Market
Value / Total Portfolio Earnings

Compare the
fundamentals
with the selected
benchmark

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 Figure 5.25 the Characteristics tab in PORT<GO>

You can tick Trend to view the trend of a specific fundamental item within a date range in both
table and graph formats (see Figure 5.26 for P/E trend). It helps you to analyze the fundamental
trend of your portfolio and benchmark.

The sub-tab displays a

very similar page as
Allocation Summary
under Holdings with
selected fundamentals,
top/bottom holdings
and weights by sector

Figure 5.26 Portfolio P/E trend by sector under Characteristics

5.2.5 Portfolio Performance Analysis

The Performance tab allows you to view the historical performance of your portfolio with
multiple total return periods with custom date ranges. It also provides seasonal analysis and
statistical summary of risk/return behavior such as standard deviation, beta, Sharpe ratio and
tracking error.

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 Up to 4-level
groupings

Figure 5.27 the Performance tab in PORT<GO>

The Main View sub-tab provides an overview of total return of your portfolio and benchmark in
different levels (up to 4 levels) within different periods such as 1 day, 1 week, 1 month and YTD
so that you can compare your portfolio return with benchmark in different periods easily.

The Total Return sub-tab displays cumulative return in graph within a custom period for
portfolio and benchmark as well as their difference to track the trend of the relative performance
over the time.

Customizable
date range for
total return

Figure 5.28 the Total Return sub-tab under Performance

Period Analysis calculates and summarizes daily return (absolute or relative to benchmark) to
give you a detailed analysis over a custom period. For example, Figure 5.29 illustrates the
relative total return analysis from 12/30/11 to 10/01/12. The Period Analysis table shows the
number of days that the portfolio beat the benchmark (winning) and coherent days (moving in
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the same direction) to summarize daily performance of your portfolio. Best-Worst shows the top
3 over-performing days and under-performing days. The graph at the bottom displays the daily
return of your portfolio and benchmark to illustrate the period analysis in graph.

Top/bottom 3
daily relative
returns

Figure 5.29 the Period Analysis sub-tab under Performance

The Seasonal Analysis sub-tab displays the month-by-month absolute and relative return of your
portfolio over a historical timeframe to examine whether seasonality exists in your portfolio. The
chart at the bottom puts the same month of different years together to easily illustrate whether the
consistency exists.

Figure 5.30 the Seasonal Analysis sub-tab under Performance

Statistical Summary displays the return and risk statistics of your portfolio and benchmark in
table format including mean excess return, standard deviation, VaR, tracking error, Sharpe ratio,
Treynor measure and beta over 3-month, 6-month, YTD and a custom period chosen from the
amber box (see Figure 5.31). It gives you a comprehensive picture of the return and risk of your
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portfolio and relative to benchmark. To view the definition of each measure, you may simply
move the mouse to the name and the definition box will pop up. Note that all the measures here
are ex-post, calculated based on the historical portfolio and benchmark data.

Click to view all the

return measures

Customize the
period here

Figure 5.31 the Statistical Summary sub-tab under Performance

5.2.6 Portfolio Attribution Analysis

The Attribution tab deconstructs the sources of your portfolio’s historical return on an absolute
or relative basis so that you can analyze outperformance or underperformance of your portfolio
against benchmark by breaking down into multiple factors including asset allocation effect,
security selection effect and currency effect.

Right click the portfolio name row

to view the return transparency

Figure 5.32 the Attribution tab in PORT<GO>

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In the Main View sub-tab, you may choose a timeframe at the top to see the return attribution
with the range. You can also right click the portfolio name row (first row in the table) to view the
return data transparency. For example, by clicking Explain return calculation (US LARGE CAP)
in the right-click box, you will be able to see the daily return of the portfolio within the selected
timeframe (base price = 100 on the starting date).

The Attribution Summary sub-tab summarizes the active return (excess return over benchmark)
attribution in both table and graph formats. The table at the top displays the return summary and
the active return attribution including allocation, selection, interaction and currency effects. It
clearly illustrates what factor(s) attributes to the excess return over benchmark.

The left graph below shows the active weight over benchmark by the grouping that you specified
(in Figure 5.33, it is GICS sector). Since the sector weights of portfolio and benchmark could
change over the time, it only displays the average active weight within the date range that you
specified in Main View.

The bar chart at the right illustrates the total attribution of each sector (or custom grouping in
general). You can also tick all the effects from the bottom to view the further breakdown of
active return (see Figure 5.33).

Figure 5.33 the Attribution Summary sub-tab under Attribution

The default methodology of return attribution used in Bloomberg follows the Brinson model.
You may refer to DOCS 2040674<GO> for more details of the calculation methodology.

To change the default settings of return attribution, you may go to 11) View and select Edit
Current View… from its drop-down menu. In the Attribution tab, you will be able to select the
attribution model as well as combine interaction effect and selection effect and embed currency
effect (in this case, it does not matter since both portfolio and benchmark are in USD).

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 Figure 5.34 Default settings for Attribution

In the attribution analysis, you are also allowed to exclude certain securities to examine the
hypothetical active return attribution. To do so, you may go to 12) Actions and select Exclude
Securities… from the drop-down menu. From the amber box of the pop-up window, you can
select to exclude cash in your portfolio (which may dilute return of your portfolio), a sector, a
region or a security. You are also able to click 1) Exclusion Editor to customize the exclusion list
by adding the securities as you like (see Figure 5.35). Let us take Information Technology (GICS)
as an example and in this case, the hypothetical attribution would be calculated as if Apple and
Google were not in the portfolio.

Figure 5.35 Feature of Excluding Securities under Attribution

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In the Attribution Summary sub-tab after the calculation being done, you will see that the YTD
active return has reduced from 19.49% to 7.17%, indicating the significant contribution by Apple
and Google to the active return.

Information Technology
has been excluded

Figure 5.36 Hypothetical Active Return after Apple and Google being excluded

You are also able to generate a report in Excel or PDF format for the selected tab by going to 12)
Actions and then Generate Report. You can also select Customize Report… from the drop-down
menu to generate a custom report combined with different tabs or sub-tabs as you like.

5.3 Portfolio Risk Analysis

In this section, we will analyze the risk of portfolio by introducing the remaining three tabs in
PORT<GO>: Tracking Error, VaR and Scenarios. Other features in PORT<GO> such as what-
if and portfolio optimization will be introduced briefly as well to provide you with more tools to
better understand the return and risk of your portfolio and achieve certain targets.

5.3.1 Introduction of Risk Factor Model

Before we continue to introduce the remaining three tabs in PORT<GO>, we will introduce the
risk factor model used in the three tabs to better understand the rationale.

The underlying logic of risk factor model is that security returns are driven by a set of common
factors, and therefore portfolio risk depends on the volatility and correlation of these factors and
portfolio’s exposure to them. CAPM is one of the simplest risk factor models and the market
return is the only factor. Unlike the explicit factor models commonly introduced in textbooks, the
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risk factor model used in Bloomberg Portfolio & Risk Analytics is an implicit factor model
where factor exposures are pre-determined and factor returns are derived. The regression formula
of the model is:

rit = b1t f1t + b2t f2t + … + bkt fkt + … + bKt fKt + εit
where

rit is security i’s return for time period t;

bkt is a pre-defined factor exposure of security i to a factor k, at time t with K factors in total;

fkt is a factor return to a factor k at time t to be derived from running the above regression;

εit is residual return of security i at time t that is not explained by the above regression.

Unlike those explicit factor models where factor returns are pre-defined (e.g. market return as the
only factor return in CAPM is pre-defined by the returns of index as proxy), factor exposures (b)
are pre-determined for each factor return based on the security nature. In general, the factors
include Market, Industry, Style, Greeks, Currency and Country. For example, the factor exposure
to Industry is set to 1 if a stock belongs to a certain industry and 0 to all other industries.

Bloomberg provides the data transparency for each factor exposures to enhance your confidence
when using the model. To view it, you may go to the Tracking Error tab in PORT<GO> and
select sub-tab Exposures. You may select the factor to display from the top amber box, e.g. for
the exposure to the factor Industry, Wal-Mart is assigned 1 to food staples and 0 for all other
industries (see Figure 5.37).

Figure 5.37 Factor Exposure transparency in the risk factor model

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The factors under Style include Momentum, Size, Growth, Leverage, Earning Variability and etc.
Therefore, the factor exposures are calculated based on the fundamentals of companies. To view
the transparency, you may select Style from the amber box under the Exposures sub-tab and
click each figure to its calculation and data transparency.

Select the factor from the amber box and

view the corresponding factor exposure

Fundamental items
to compose the
factor exposure
Click the figure to view the transparency;
equivalent to running RTQT<GO>
Click each item to view the formula

Figure 5.38 Factor Exposure transparency of for the Style factor

You may also notice that there is more than one model which you can choose from the Risk
Model amber box in Main View of Tracking Error, from global equity fundamental to regional
models such as Europe, Asia and Japan (see Figure 5.39). You may select an appropriate model
based on the securities in your portfolio.

Figure 5.39 Model list under Tracking Error

The global model covers more securities than regional models while regional models may be
more accurate given the smaller universe covered. For example, the factor exposure for factor
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Size may be higher for 5 HK in the Asia model than in the global model as there are more large
companies in the universe of the global model. To use the regional model, you may need to bear
the risk that some securities may not be covered by the model. For example, if you apply Asia
model to the portfolio US Large Cap, you will see 6 exceptions (all the securities in the portfolio)
at the bottom and you can click it to see the securities and reason(s).

Figure 5.40 Exception(s) not covered by the model

With the pre-defined factor exposures as illustrated above and weekly returns r, we can run
regression on the formula in page 22 to obtain the factor returns f. With the historical time series
of factor returns from regressions, we can then calculate the factor covariance matrix F by
decomposing it into a correlation matrix C and a diagonal factor volatility matrix D and applying
different exponential decay weighting to the two parts:

F=DCD

Where C uses a longer half-life of 52 weeks and D uses a 26-week half-life since the Bloomberg
empirical tests showed that these are the optimal parameters for describing the volatility
dynamics of Bloomberg’s factor returns.

The risk of the portfolio due to the factors will hence be found by cross multiplying the
exposures vector with variance covariance matrix. The non-factor return in this case refers to the
returns that are not explained by factors while the unexplained return here is caused by a timing
discrepancy since the factor returns are calculated weekly while portfolio rebalance could be
done intra-week.

One advantage of such implicit model is it is more intuitive. For example, if the portfolio has
underperformed the benchmark recently and it is over-exposed to the size factor compared with
the benchmark, you may probably add more small size companies into the portfolio. Explicit
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models may be limited to the pre-defined factors because it is difficult to find a proxy for the
factor returns of some intuitive factors such as momentum and leverage. Such model is also very
responsive to changes in asset characteristics: a sudden change in fundamentals, due to an IPO
for example, can be instantly incorporated into the model.

If you are interested in knowing more details of the model, you may go to BPRD<GO>
(Bloomberg Portfolio & Risk Documentation) for the research white papers under Research
Papers. You can take a look at other documents related to Bloomberg Portfolio & Risk in this
page.

Figure 5.41 Bloomberg Portfolio & Risk Documentation: BPRD<GO>

5.3.2 Portfolio Tracking Error Analysis

With an idea of the risk factor model, we can continue to introduce the remaining tabs in
PORT<GO> which are built based on the model. For example, in the Main View sub-tab under
Tracking Error, we can select S&P 500 as the benchmark and US Equity Fundamental as the risk
model to examine the tracking error of the portfolio.

In the Summary sub-tab as shown in Figure 5.42, we can see 14.68 highlighted in green as the
tracking error which measures the deviation of excess return over benchmark and 9.36 can be
explained by the factors in the model. Note that the tracking error here is ex-ante since it is
derived from the risk factor model and it has some prediction power to help you better
understand the future risk of your portfolio. From the bar chart at the bottom, we can see clearly
where the risk comes from.

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 Total Risk =
(Factor Risk2 + Non-
Factor Risk2)1/2

Breakdown of the tracking

error into different factors

Figure 5.42 the Summary sub-tab under Tracking Error

To see the breakdown of each factor risk, you can click the figure e.g. 7.95, the active risk
attributed by the factor Style, to display the active risks attributed by the factors within Style
such as size, leverage and earning variability in the bar chart at the bottom. More interestingly,
you can click Exposure at the top right corner of the chart to view whether each factor is under-
or over-exposed to the benchmark.

From the Figure 5.43, you can see that the portfolio is over-exposed to the size factor and under-
exposed to the leverage factor (it is intuitively correct since all the companies in the portfolio
have very large market cap and Apple which weights for more than 50% of the portfolio has not
issued any debt). Therefore, in order to reduce the tracking error, you may add small size and
more leveraged companies into portfolio. To verify what companies are small sized or more
leveraged, you can run RTQT<GO> after loading the company ticker and choose the
corresponding factors to view their exposures.

Now you may understand better how the implicit risk factor model can easily identify where the
active risk comes from and how to reduce it.

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 Since both the
entire portfolio
and benchmark
are invested in the
US market, they
have the same
market risk (non-
zero) while the
active risk is zero.

Figure 5.43 identify the active risk of the portfolio

In the Factors sub-tab, it lists all the factors in the model with their exposures and risks in table
view. The Exposure column displays the exposures to each factor of the portfolio, benchmark as
well as the active exposures (portfolio – benchmark). The Marginal (X100) column indicates the
impact on the portfolio tracking error in basic points (bps) of a 1% increase of factor exposure.
For example, in Figure 5.44, if exposure to Growth factor increases by 1%, the tracking error
will increase by 0.55 bps.

Figure 5.44 the Factors sub-tab under Tracking Error

The Risk Bets sub-tab displays the top and bottom bets based on the category selected at the top.
For example, if we choose Active Risk as the category and group it by Securities, it will list out
the top and bottom 5 securities in terms of active risk (sorted by the Tot. Active (Std %) column
which is calculated by the standard deviation of the factor returns multiplied by the absolute
31
active exposure). It helps you to identify the most and least influential securities to the tracking
error and you may pay extra attention to these securities when you add or reduce their holdings.

Figure 5.45 the Risk Bets sub-tab under Tracking Error

The Trends sub-tab allows you to view the risk trend historically. You can choose the indicators
from the left and the methodology from the top amber box. The Current Portfolio method uses
current security weights, exposures and non-factor risk whereas the Historical Risk method uses
historical weights, exposures and non-factor risk. The Historical Exposure (X100) option in the
Methodology box displays the historical values for the factor exposures. It allows you to see
whether you have been shifting your bets across the different style stocks or industries
historically when you rebalanced your portfolio.

Figure 5.46 the Trends sub-tab under Tracking Error

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The Factor P&L sub-tab graphs the total active return and its breakdown into factor return, each
factor group, non-factor and unexplained returns within a selected date range from the top amber
boxes. For example, in Figure 5.47, by choosing all the factors in the Style group, you can see
that the Momentum factor contributes most to the active return for the week of 09/19/2012.

The Exposures
sub-tab has been
introduced in
section 5.3.1

Figure 5.47 the Factor P&L sub-tab under Tracking Error

You can also choose the line chart to view the historical trend of the factor P&L. For example, in
Figure 5.48, the TradeAct factor contributed to the active return significantly from 07/25/2012 to
09/26/2012 and if you believe the trend faces upward pressure recently, you may tend to invest
less in this factor.

Figure 5.48 Factor P&L trends under Tracking Error

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5.3.3 Portfolio Value at Risk (VaR)
Value at Risk (VaR) is the maximum amount that you can lose on your portfolio given a certain
confidence level. For example, if 1D VaR at 95% confidence level is 1 million, it means there is
a 95% chance that your 1 day loss on your portfolio will not exceed 1 million. Unlike tracking
error which uses percentage term to represent risk, VaR is easier to understand and interpret by
using dollar term for risk.

The VaR calculation in the VaR tab of PORT<GO> is based on the Bloomberg risk factor
model with three methodologies: Parametric, Historical and Monte Carlo.

The Parametric method which is the easiest to implement assumes that returns are normally
distributed and uses the historical factor returns obtained from the regression to calculate VaR.

The Historical method incorporates actual historical events into simulations without the
assumption of normal distribution of return. It is still not forward looking and assumes that
history will repeat itself. It uses current exposure and historical factor returns to calculate the
returns of the portfolio over the time range (1, 2 or 3 years). Non-factor volatility from the risk
factor model is also used for simulating non-factor returns. For each day in the time range, the
factor and non-factor returns are summed up to get the return of the portfolio and such daily
returns are rearranged according to sign and magnitude so that we can take the percentile of the
arranged returns based on the confidence level chosen.

The Monte Carlo method is forward looking with simulated scenarios and the most computation
intensive. It is more flexible in terms of the instruments that are being revalued and more suitable
for derivatives as it does not assume that a security’s price has linear relationship with some
factors. It estimates joint distribution of future factor and non-factor returns and draws 10,000
simulations from the joint distribution and the return of each scenario is then calculated based on
the exposure of the portfolio. Similar to the Historical method, such returns are rearranged
according to sign and magnitude so that we can take the percentile of the arranged returns based
on the confidence level chosen.

With these concepts in mind, it is easy to understand the VaR tab in PORT<GO>. Similar to the
Main View sub-tabs under other primary data tabs, you can customize the columns for VaR
related data as well as choose model, horizon and confidence level.

In the VaR Comparison sub-tab, different VaR values calculated by each methodology and in
different confidence levels are displayed in the table for comparison. By clicking each figure, the
table at the bottom will display the VaR breakdown into sector and security levels to give you a
detailed analysis.

For the terminologies shown in the table, Marginal VaR refers to total change in portfolio VaR
given an increase in 1 dollar of exposure to a particular sector or security. Partial VaR means
total change in portfolio VaR if a particular sector or security is removed entirely from the
34
portfolio. Conditional VaR is also called expected shortfall, measuring the expected loss of the
portfolio when the confidence level is surpassed.

Figure 5.49 the VaR Comparison sub-tab under VaR

The Distribution sub-tab displays the distribution of P&L for the portfolio (or benchmark or
active) that are generated from the selected method. It transfers VaR into P&L probability
distribution to give you an even more straightforward picture. The table at the right also shows
the P&L near the selected confidence level from the bottom. Note that this sub-tab is applicable
for Historical and Monte Carlo methods only.

To quickly change
the method, you can
go to 13) Settings and
select Calculation
Defaults… from the
drop-down menu

Figure 5.50 the Distribution sub-tab under VaR

35
The VaR Simulations sub-tab shows the individual simulations to provide the transparency of the
model. For example, in Figure 5.51, you can see 10,000 simulations for the Monte Carlo method
in the table and the scenario P&L graph at the bottom.

Figure 5.51 the VaR Simulations sub-tab under VaR

The Factor Breakdown sub-tab shows the factor exposures of the portfolio together with the
factor volatility and how much volatility of the portfolio is attributable to these factors. It gives
you a basic idea of how the model is linked to the portfolio volatility.

Figure 5.52 the Factor Breakdown sub-tab under VaR

5.3.4 Portfolio Stress Test

One of the limitations of VaR to measure portfolio’s risk is that the loss could be ambiguous
beyond the confidence level. Therefore, it is not a good indicator of risk for extreme scenarios
such as financial crisis and natural disaster. We may use stress test instead to examine the
portfolio’s P&L, for example, what could the loss of your portfolio be if Lehman default in 2008
happened again?

36
The Scenarios tab in PORT<GO> allows you to test your portfolio’s P&L under a pre-defined
set of scenarios such as Lehman Default, Greece Financial Crisis and Japan Earthquake based on
the Bloomberg risk factor model (see Figure 5.53).

Pre-defined set of
scenarios:
Bloomberg Stress
Scenarios

Figure 5.53 the Scenarios tab in PORT<GO>

You are also allowed to create your own scenarios. To do so, you may click the icon next to the
Set amber box in the Main View sub-tab and click 1) New at the top left to create new scenario
or scenario set (see Figure 5.54).

Figure 5.54 Creating your own scenario

37
You can give a name to the new scenario and follow the steps to specify the stress macro factors,
FX rates, swap rates and etc. if applicable. Let us use US banking down 20% as an example. In
this case, you may go to 8) Stress Model Factors and select US Banks under Industry of US
Equity Fundamental Model. You may specify -20 in the amber box as shown in Figure 5.55.

Figure 5.55 Choosing Stress Model Factors

In the 9) Propagation step, you can specify whether to let the implicit shocks that we made
earlier propagate to other factors in the risk factor model.

Instruction of
the selected step

Figure 5.56 Specifying propagation in the custom scenario

In the 10) Scenario Sets step, you may select a scenario set to add the new scenario to or create a
new set later for the new scenario. Save the scenario in the last step and then load the set
containing this scenario and you can view the P&L as if US banking down 20% (see Figure 5.57).

38
 Created a set
called US Equity
Model to add the
custom scenario
US banking Down
20% into it as an
example

Figure 5.57 Custom Stress Scenario in PORT<GO>

In the Best & Worst sub-tab, the 5 best and worst scenarios from the selected set are displayed
with the corresponding P&Ls, P&L % and stress market values (see Figure 5.58). The bottom
table shows the best/worst sector or security of each scenario to give you an idea of which sector
or security would be affected most or least if each scenario occurred. To see the full list of
scenarios in the selected set, you may go to the Scenario Detail tab.

Figure 5.58 the Best & Worst sub-tab under Scenarios

5.3.5 What-If Analysis and Portfolio Optimization

Apart from examining the risk of existing portfolios in PORT<GO>, Bloomberg also allows
you to create hypothetical portfolios by assigning new security/sector weights to see what the
risk and return would be. To do so, you may go to 12) Actions and tick Enable What-If from the

39
drop-down menu. A new column for what-if weights will be generated for you to assign new
weights for sectors and securities (see Figure 5.59).

Figure 5.59 What-If feature in PORT<GO>

For example, you may think the weight for the information technology sector is too high which
resulted in a high tracking error and would like to lower its weight to see more diversification.
Meanwhile, you have a bullish view on the health care and consumer staples sectors given the
current economic condition. In this case, you can assign new weights for each security and sector
as you like. We may use Figure 5.60 as an example to illustrate the feature.

Save as a new
portfolio once the
what-if weights
are specified

Original weights
for comparison
and what-if trades
to achieve the
what-if weights

Figure 5.60 Custom weights for What-If analysis

Once the weights are specified, you may click Save at the top right and to save the what-if
portfolio and load the portfolio from the list to run the portfolio analytics. For example, in Figure
40
5.61, we can see the tracking error of the what-if portfolio has lowered to 8.25% from 14.68%
after more even weights being assigned.

Figure 5.61 Tracking error of the new portfolio

You may also notice such active risk is still not minimized and Bloomberg does provide
optimization tools to minimize the active risk and other unconstrained/constrained optimization
targets based on the Bloomberg risk factor model. To do so, you may go to 12) Actions and click
Launch Optimizer from the drop-down menu.

Figure 5.62 Portfolio Optimizer in PORT<GO>

You can set multiple goals to minimize or maximize different terms with multiple levels of
constraints such as maximum level of turnover (portfolio level), maximum weight for all stocks
domiciled in a certain currency (group level) and maximum weight for individual securities
(security level). Let us use an example to illustrate the feature of the portfolio optimizer.
41
 Example: you would like to minimize the tracking error of the portfolio US Large Cap to the
benchmark S&P 500 by buying and selling the stocks in the benchmark (not only limited to the
initial portfolio). However, due to the high trading cost, you would like to limit the number of
trades to 5 at maximum. Meanwhile, since you are satisfied with the active return of the portfolio,
you would also like to keep the original weights of all the securities stable by limiting a ± 15%
weight change relative to the initial portfolio.

To achieve the goal of minimizing the tracking error of the portfolio, you may select Action as
Minimize and Field as Active Total Risk under Goal Definition. To specify the trading universe
as all the stocks in the benchmark, you may choose Current Benchmark under Trade Universe.
To limit the number of trades, you may click Add Group Constraint and select Number of Trades
from the list (under Execution) and specify 5 under the Max column. To limit a ± 15% weight
change relative to the initial portfolio, you may specify the min and max weights as -15 and + 15
at the bottom. Please refer to Figure 5.63 for all the goal and constraint settings.

Specifying Current
Portfolio as the
trading universe
will only allow you
Relative to None refers to trade the
to the absolute weights securities in the
for securities while initial portfolio for
Relative to Init. Portfolio optimization
refers to the relative
weights, e.g. if the
initial portfolio
contains 50% of Apple,
-15 to 15 means the
optimized portfolio can
only contain 35% to
65% of Apple in weight
Figure 5.63 Goal and Constraints setup for the optimization example

After setting up all the goals and constraints for the optimization, you can click 1) Run at the top
left to view the result (see Figure 5.64).

42
 Active Total Risk
has lowered from
14.68 to 9.36

Figure 5.64 Optimization result with proposed trades

Exercise
Create an equity portfolio using either PRTU<GO> or BBU<GO> and run PORT<GO> to
analyze its return and risk. Run What-If and Optimizer to further examine its analytics.

43