Last month, we introduced readers to Hidden Levers, a platform designed to help advisors apply macroeconomic factors to the investment process. In that article, we discussed how macroeconomic models can be used both as an offense strategy, to identify promising investments, as well as defensively, to hedge a portfolio should an analysis of the current economic conditions call for it.
Meanwhile, other firms are striving to deliver actionable macroeconomic information to advisors over the Web as well. MacroRisk Analytics is one such firm. At first glance, it may appear that these competing macroeconomic platforms are interchangeable, but as you delve deeper, differences become more apparent. Since we began initial coverage of Hidden Levers last month, we thought it appropriate to follow up with our initial thoughts on MacroRisk Analytics this month.
MacroRisk Analytics claims to be the first firm to offer advisors a "standardized, statistically sound, and scientifically tested method of measuring the economy's influence on investment prices." They further claim that "MacroRisk Analytics lets you show clients exactly how the economy is changing, explain its likely impact on their investments, lower their economic risk, shape their holdings to take advantage of the economic climate, and more." While I'm not sure that all of the above assertions are equally defensible, there is little doubt that the majority of advisors can benefit from macroeconomic tools.
Until fairly recently, only a small minority of advisors that I know weighted current macroeconomic factors heavily in their investment process. In the wake of the market meltdown of a few years ago and the subsequent rebound, advisors are more open to the idea of incorporating macro filters to their investment policy process. So if firms like MacroRisk Analytics can convince advisors that their products actually work, and that they can be delivered at an affordable price, the timing is right for these tools to gain wider acceptance.
MacroRisk Analytics is a creation of the Center for Computationally Advanced Statistical Techniques (c4cast.com Inc.). c4cast was founded in 1998 by a team of financial experts, statisticians, computer scientists, economists and econometricians, led by two finance professors, G. Michael Phillips and the late M. Chapman Findlay. With their backgrounds in economics and finance, the founders of MacroRisk Analytics believed that many of the economic assumptions on which commonly accepted investing strategies were based were simplistic, or even inaccurate. In 1999, they decided to test how the changing economy impacted stock prices, and they discovered what they believed to be a superior method of analyzing how the economy relates to investment values. The result of this research is something they call the "Eta analysis."
Essentially, the firm believes that 18 consistent macroeconomic and financial variables account for over 90% of the current prices for most stocks, mutual funds and indices. Using a variety of statistics derived from these models, economic risk can be measured and managed in a consistent way, helping improve performance and risk-exposure in different economic conditions by letting managers create more economically robust portfolios.
More recently, c4cast has been building out the MacroRisk Analytics platform based on their years of research and their ten patents with the goal of allowing advisors to benefit from MacroRisk Analytics' predictive and analytical capabilities.
An Overview Of The Software
When you log in to the platform, you arrive at the dashboard. A navigation bar at the top of the screen provides access to the various areas of the application (MacroRisk Factors, Reports, Screening, Optimization, and Account). In the upper left, below the navigation bar is a "Quick Check." Here, you can type in a symbol and receive a summary of the related security. For example, when I typed in Cisco's symbol (CSCO) I received a Composite MacroRisk Index (CMRI) number indicating that it was on the lower end of the index, had a neutral economic climate rating (ECR) and had an R squared of 92 (meaning that 92% of the price of CSCO is attributable to the economy as opposed to company-specific factors). To the right of the Quick Check is a Quick Look at the indices. Here, you can see in chart format the CMRI, ECR and R2 for ten major U.S. and foreign indices. Below, there is a bar graph indicating the current MacroRisk status of the individual factors. Factors within their normal range are illustrated in blue, while those outside their normal range (more than two standard deviations from their previous year of data with a three-month lag) are illustrated in red, so you can immediately focus on what is important at a given moment in time.
The dashboard also contains links to any saved portfolios and any saved buy lists you may have created. In addition, it contains information about your subscription status and a link to your account profile.
The MacroRisk Factors dropdown links to a couple of areas. The first is the MacroRisk Factors section. Here, we get a more detailed view of the graph on the dashboard. You can click on the name of any factor and generate a graph of that factor's historical values. The Economic Status page provides further information about where the 18 factors are from a historical perspective, including their standard deviations. You can also compare the current data to that of another point in time if you wish.
At the Reports drop-down, reports are divided into two categories: those that can be applied to a security or portfolio and those that can be applied to a portfolio only. The analysis overview report gives you an asset's economic climate rating, CMRI and R2 plus its CAPM alpha and beta. The macro risk profile provides the CMRI, R2, Eta profile and Eta measures plus statistics for each MacroRisk factor. The Beta+ report supplies not only standard alpha, beta and R2, it also provides separate statistics for each in up and down markets. Other statistical information includes the Sharpe ratio, the Sortino ratio, the Treynor ratio, the standard deviation and the tracking error.
The portfolio reports include a holdings overview, a client portfolio analysis and a portfolio comparison report. The first gives you the economic climate rating, the CMRI and the R2 for each holding or item on a buy list. The second gives you a composite Eta analysis of the portfolio, the Beta+ report for the current holdings and analysis overviews for each holding. The comparison list allows you to compare the holdings of two portfolios or buy lists.
Under the screening tab you can screen, sort and filter data in various ways. If you create a screen that you would like to use in the future, you can save the parameters for future use. You can also save one or more buy lists.
The optimization section allows you to optimize portfolios. To start you upload a portfolio. Portfolios can be saved for reuse. You then choose an optimization method. You can optimize on the Sharpe ratio, the Sortino ratio or one of three MacroRisk levels.
One MacroRisk level allows you to minimize the portfolio's exposure to the economy. Another optimizes the portfolio with an Eta profile that matches the date's selected current economic stats while keeping the portfolio's CMRI at or below that of the current S&P 500's. The third method is similar to the previous one, but it allows the CMRI to be up to twice that of the S&P 500.
So if you are concerned about a market drop or if you just want to take a conservative stance, you might optimize using the first MacroRisk method. If you are neutral on the market or mid-risk, you might choose the second method. If you are investing aggressively, or very bullishly, you might select the third method.
Once you've selected an optimization goal, you can select how much of the current portfolio you want to sell. You can run a 100% optimization, or you can say that you are willing to sell no more than 20% of the portfolio. You can choose a dollar amount as opposed to a percentage if you wish. You can also choose to exclude individual assets from sale, or force the sale of designated assets.
Setting up buys works in a similar fashion. You can choose not to buy anything with the cash generated by sales, invest a percentage, or invest a dollar amount. You can set minimum lot amounts, maximum holding percentages, etc. You can also create a buy list that the application will make purchase selections from. Once the optimizer has run, you can view suggested buys and sells, make edits and compare the potential before and after portfolios.
So how specifically can advisors benefit from this system? A few examples should suffice. It can help you "immunize" a portfolio. The application allows you to uncover what factors a portfolio is particularly vulnerable to, and then it can optimize the portfolio to mitigate those risks. The application also makes it easy to assess the current economic environment based on the 18 MacroRisk factors. If the factors are highly favorable, you may want to ramp up your equity exposure for all clients; if they are negative, the opposite may apply.
MacroRisk Analytics provided another example of how you might use their system. You could load all 500 S&P stocks into a portfolio and view the individual holdings from time to time in order to gauge the economic climate ratings of the S&P components. If an overwhelming majority of them flash low ratings, as they did in 2008, it might indicate trouble ahead for the index.
Initial Impressions
Macroeconomic tools such as this are new to the advisory world, so advisors will be skeptical initially. MacroRisk Analytics claims they have been using similar tools for some time with impressive results. If advisors believe the model works, they will become fans. Beyond that, the question becomes: How good is the software and the user experience?
It's OK, but there is room for improvement. The MacroRisk Analytics team seems to understand that there are different types of financial advisors with different needs. Today, I suspect that they will appeal more to the investment specialist and the portfolio geeks as opposed to the mainstream planner.
There are a number of reasons for this. First, the application is not as user friendly as it could be. It is sophisticated, it has a lot of power, and it has a lot of flexibility. This is great for those who want to get their hands dirty running sophisticated analyses, what-ifs, etc.
Most advisors, however, have more limited needs, and they want to get in and out of the application as fast as they can. MacroRisk Analytics doesn't really facilitate this. For example, if you want a "quick report" on an equity, ETF or mutual fund, you can get it by entering the symbol on the dashboard page and hitting the enter key. If you want the full report, however, you have to navigate to a separate page, enter the symbol again, and generate the report. Why not have a quick report and full report button on the dashboard page?
There does not appear to be any reason that the two security level reports cannot be combined into a one-sheet report. Why force users to run two when one will do (the single page summary approach has worked pretty well for Morningstar, Value Line and others).
As I moved around the Web site, comparisons to Hidden Levers, which I reviewed last month, were unavoidable. For mainstream advisors, the Hidden Levers approach, with preformatted scenarios, portfolio stress tests and portfolio suggestions tied to economic scenarios, etc., was more user-friendly. MacroRisk Analytics needs to adopt this approach. For example, if the company thinks it is useful to create a portfolio of all the S&P 500 stocks in order to browse for patterns, why tell the user to do it? The company has all the data. Create the portfolio for me, tell me the rationale for using it, and let me access it with a single mouse click.
MacroRisk Analytics has great potential, particularly if it has the sort of predictive powers that the firm suggests that it does. It will likely attract highly analytical planners initially; however, if it works on the user interface and the reports, it will attract a much broader advisor audience. Advisors certainly value quality data, but it is clear to me from sales trends in financial planning, portfolio management, rebalancing and other software niches that advisors put a substantial premium on usability and reporting. If MacroRisk Analytics can up its game in these areas, advisors will take notice