Models: X-Risk

X-Risk refers to danger of extreme performance events.  Most risk measures assume orderly variation of potential outcomes.  Beta, standard deviation, drawdown or value-at-risk all rest on such assumption. These are the daily workhorses of risk analysis, but are often blind to intimations of extraordinary risk.  The X-Risk model is tuned to the possibility of abnormal shocks and anomalies.

Fund Shock Example 1: 

Going into 1994, Piper Jaffray Institutional Government fund seemed like a conventionally prudent investment.

  • Annualized standard deviation = .061

  • Lehman Long T-bond index     =.086

This volatility was about in line with many or most other bond funds; a seemingly "safe" holding.  But then, from January to June '94, investors lost more than 25% while the Lehman index was down only 8.4%.  

It turned out the fund had substantial exposure to risky derivatives strategies. But that risk was statistically discernable before the meltdown. 

While PJIGX may have seemed comfortable by the usual measures, the X-Risk model says this was not at all a typical, conventional, middling-risk bond fund.  The X-Risk factor--for months before the meltdown--was 4.35, more than three times greater than normal safety levels.  The possibility of portfolio shock was substantial.

The Piper finding was part of a 1995 X-Risk analysis comparing  indexes and funds  with-and-without notable derivatives exposure. All the derivatives-laced funds showed X-Risk far in excess of conventional bond funds and indexes... and all suffered disproportionately when the bond market dropped in 1994. The potential for outsized losses existed--and was affecting returns statistics--well before the actual market shock emerged.

Fund Shock Example 2:

In October 2000, two well regarded municipal bond funds (Heartland High-Yield Municipal and Short Duration High-Yield) suddenly tanked by 44% and 70% in a single day! 

The WSJ headline said "Heartland Bond Meltdown Stunned Investors." Stunned indeed!  But in fact, these two funds showed dangerous statistics before they tanked.

Measure Hi-Yield Mun Short Dur Hi-Y Lehman Long
Std Deviation 1.4% 2.2% 8.9%
X-Risk 1.33 2.05 1.00

Both funds would seem conservative by conventional measures, with general volatility running 1/6 to 1/5 of the Lehman Long bond index (August YTD StdDev). But X-Risk was dangerous at best, running 33% to 100% higher than the index.

Shocks can occur with no possible prior detection, but often the seeds of surprise are sown well before the event.   With X-Risk you can monitor for signs of portfolio shocks waiting to happen.

X-Risk is available on custom subscription basis. You can track X-Risk status in one-time or occasional audit, or in scheduled periodic review.  You select the scope of funds and portfolios, you choose report frequency, and medium of delivery to suit your needs.

To enquire about X-Risk applications with your own data and funds, you can leave a message back at the Models page, or use the master checklist of Analytix Services.  Or call directly anytime, at (603) 643-6430.


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