Marke Insigh Macro Sensiive Porfolio Sraegies Marke Insigh Macro Sensiive Porfolio Sraegies Macroeconomic Risk and Asse Cash Flows Kur Winkelmann, Raghu Suryanarayanan, Ludger Henschel, and Kaalin Varga Kur.Winkelmann@ Raghu.Suryanarayanan @ Ludger.Henschel@ Kaalin.Varga@ Absrac: In his paper, he second in a series, we show ha cash flows earned by differen equiy porfolios can respond differenly o persisen macroeconomic shocks o real oupu, and ha hese differences can emerge over longer ime horizons. Porfolios wih cash flows ha exhibi a greaer long run response o macro shocks can command a higher expeced reurn in he long run. As wih any oher reurn, he higher long run expeced reurn for hese porfolios is compensaion for risk in his case, he risk of a persisen shock o rend growh in real GDP. Why This Maers: Many insiuional invesors care abou he cash flow beas of heir invesmens relaive o he sae of he economy. Significan differences can emerge in cash flow beas over long horizons ha are no eviden on shor horizons. These cash flow differences can be imporan for effecive asse allocaion. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 1 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies Inroducion Over he pas five years, invesors have encounered a puzzling paern: alhough global macroeconomic condiions have improved somewha, developed economies have coninued o experience below rend growh. By conras, global equiy markes have rebounded significanly since he financial crisis in 2008. The conras beween weak economic growh and srong equiy marke performance has sparked an ineres in a deeper undersanding of he relaionship beween macro economic variables and macro risk on he one hand, and asse pricing and asse risk on he oher. In our previous paper in his series, we argued ha macro risk is bes defined as a persisen shock o rend growh raes. 1 Under his definiion, he effecs of large shocks o he macroeconomy are only revealed over long ime horizons. Consequenly, o fully undersand he impac of such shocks, risk analyss should use asse pricing frameworks ha incorporae horizon effecs. To accomplish his effecively, we also proposed ha analyss should rever o firs principles and look a he impac of macro shocks on asse cash flows separaely from he impac on discoun raes. This paper focuses on he analysis of he impac of persisen shocks o rend growh on asse cash flows. Our analysis focuses on he US equiy marke and US real esae (where we use he MSCI USA Real Esae Index as a proxy for real esae). Our ineres is wheher some pars of he equiy marke respond differenly han ohers for a given shock o real oupu. To ha end, we consider hree disinc ypes of equiy porfolios: 1. Size and syle sored porfolios. 2. Indusry porfolios. 3. Sraegy porfolios (e.g., Momenum porfolios). Our principal conclusion is ha he cash flows earned by differen porfolios can respond differenly o persisen shocks o real oupu, and ha hese differences can emerge over longer ime horizons. For example, condiioned on a posiive shock o rend growh in GDP, cash flow growh may be larger for small cap porfolios han large cap porfolios and larger for financial firms han uiliies. However, hese differences can gradually accumulae over several years following he shock. The long run response of asse cash flows o pervasive macro shocks suggess ha macro shocks are associaed wih undiversifiable financial risk. Because asse cash flows respond only over a long horizon, his risk is a long run risk. As wih all undiversifiable risk, his risk mus be priced. Because porfolios respond differenly o macro shocks, hey will have differen exposures o long run risk, and consequenly have differen prices. We will explore asse pricing and long run reurns in he nex paper in his series. Characerizing Asse Cash Flows Our ineres in asse cash flows is o undersand he evoluion across ime of a persisen shock o rend oupu. The focus on shocks carrying a long run impac and he evoluion of asse cash flows across ime means ha we are ineresed in a dynamic model. The inclusion of several variables means ha we are also ineresed in a mulivariae model. 1 Kur Winkelmann, Ludger Henschel, Raghu Suryanarayanan, and Kaalin Varga, 2012, Macro Sensiive Porfolio Sraegies: How We Define Macroeconomic Risk. MSCI Marke Insigh, November 2012. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 2 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies The sandard saisical oolki for dynamic models is ime series analysis. The vecor auoregression (VAR), inroduced by Sims (1980a, 1980b), is a common ime series approach o mulivariae models. This srucure says ha each variable in he sysem depends on is own lagged values and he lagged values of all of he oher variables. Thus, a one ime shock o one variable in he sysem can poenially have an impac on all of he oher variables in he sysem for many quarers or years. 2 Our presen analysis invesigaes he link beween porfolio cash flow growh and he persisen shocks o real oupu growh for 13 porfolios. We argued in our previous paper ha in order o capure persisen shocks o real oupu growh, we require a long run risk model for real GDP growh. In ha paper, we used a vecor auoregression (VAR) model wih wo variables and wo lags: he log of real GDP growh, and he log of he Corporae Profis o GDP raio. I is he laer variable ha helps o idenify he persisen shocks o oupu growh. In his paper, we furher build on his long run risk model by appending a paricular porfolio s log of dividend growh as a hird variable in he model. Thus, for each porfolio of ineres, we esimae a separae hree variable VAR wih wo lags. Besides he US equiy marke porfolio, we consider wo syles (value and growh), wo size porfolios (small cap and large cap), wo sraegies (momenum and minimum volailiy), wo cyclical indusries (financial services, maerials), wo defensives (uiliies and consumer saples), echnology hardware and equipmen, and real esae, which we proxy wih he MSCI USA Real Esae Index. Once he parameers in he VARs have been esimaed, he VAR models can be used o undersand dynamic relaionships. The principal analyical ool in a VAR is he impulse response funcion. This family of funcions shows he response, across ime, for all of he variables in a sysem, including a shock o one variable, or a combinaion of shocks. In our analysis, we will focus on he cumulaive impac on porfolio dividend growh o a posiive and persisen shock o he rend growh of US GDP. Our impulse response funcions porray he erm srucure of porfolio cash flow bea wih respec o macro risk. 3 Asses ha have a low long erm cash flow bea o rend growh will have impulse responses ha end owards zero. By conras, asses ha have a high posiive long erm bea will have impulse responses ha are posiive, and meaningfully differen from zero in he long run. For hese asses, conribuions o cash flow growh risk from macro risk will dominae in he long run. 4 Cash Flows Vary in Their Response o Economic Shocks Figures 1 4 show he impulse response funcions for porfolio cash flows for he 13 porfolios discussed in he previous secion. Each graph shows he cumulaive impac on dividend growh condiioned on a persisen and posiive macroeconomic shock o rend growh in real oupu. Figure 1 focuses on size and syle porfolios. The exhibi plos he response of dividend growh for value, growh, small cap and large cap porfolios o a shock o rend growh in real oupu. For comparison purposes, he impulse response for he marke porfolio is also included. I is eviden from Figure 1 ha he immediae impac on dividend growh raes is close o zero for all porfolios, and ha i is difficul o meaningfully disinguish beween he porfolios. Pu differenly, if 2 See Appendix A for a more deailed descripion of VAR models and heir use. 3 The noion of cash flow bea is similar o ha described in Campbell and Vuoleenaho (2004). They consider a one period bea, measuring i relaive o marke risk. Following and exending he analysis in Hansen, Heaon, and Li (2008), we measure he beas over differen invesmen horizons, relaive o macro risk. 4 The Appendix presens a decomposiion of porfolio cash flows ino a long run componen and a shor run componen. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 3 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies real oupu increases dramaically one quarer, dividends are unlikely o show much of an immediae response, regardless of size and syle. Across ime, however, cash flows o he marke porfolio grow by roughly he same amoun as he original GDP shock and meaningful differences emerge across he size and syle sored porfolios. Afer five years (weny quarers), dividends for he value and small cap porfolios have grown roughly four imes as much as hose for he marke porfolio; dividends for he large cap porfolio have grown a abou he same rae as he marke porfolio; and he growh porfolio dividends remain unaffeced by he posiive shock o rend growh. Thus, value and small cap porfolios have a much higher long erm cash flow bea o macro risk han growh and large cap porfolios. Figure 1: Value and Small Cap are More Highly Sensiive o he Real Economy Relaive o Growh, Large Cap, and he Marke. Impac (%) (Percenage) 10 9 8 7 6 5 4 3 2 1 0 0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 64 68 72 76 80 Small Large Value Horizon (Quarers) Growh Marke The Figure depics he cumulaive impac of a 1.5 percen permanen increase in real oupu on Small Cap, Large Cap, Value, and Growh, and he Marke porfolio dividends. The syle porfolios are long only, respecively sored by size and book o marke. The porfolio dividends are consruced from oal reurn and price reurn series available from Kenneh French s websie. The impulse responses are based on quarerly daa for porfolio dividends, real GDP, and real aggregae corporae profis, from 1950 o 2011. Figure 2 shows he impulse responses for he indusry sored porfolios. The indusries analyzed include financial services, maerials, echnology equipmen, uiliies and consumer saples. The char plos he impulse responses for hese five indusries and again conrass he indusry responses o he marke porfolio. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 4 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies In common wih he size and syle porfolios, differences in he responses of dividend growh only emerge afer several years. Virually all porfolios show very lile change in dividend growh raes in he quarer immediaely following a shock o rend growh. However, by five years (weny quarers), dividend growh raes are meaningfully differen across indusries. Cyclical indusries such as financial services and maerials show a persisenly high dividend growh rae ha exceeds ha of he marke porfolio, and hese indusries exhibi a high cash flow bea. 5 By conras, dividend growh raes for defensives such as uiliies and consumer saples show virually no change, wih a nearly zero cash flow bea. Finally, dividend growh in echnology equipmen mirrors he marke, albei a a slighly lower rae 6. Figure 2: Cyclicals Carry Higher Economic Exposure Relaive o Defensives and o he Marke. Impac (Percenage) 16 14 12 10 8 6 4 2 0 2 0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 64 68 72 76 80 Horizon (Quarers) Uiliies Maerials Marke Consumer Saples Financials Technology Hardware and Equipmen The char depics he cumulaive impac of a 1.5 percen permanen increase in real oupu on he MSCI USA Uiliies, Consumer Saples, Maerials, Financials, and Technology Hardware and Equipmen Index, and he Marke porfolio dividends. The impulse responses are based on quarerly daa for each indusry porfolio dividends, real GDP and real aggregae corporae profis, from 1995 o 2012. 5 The global recession and financial crisis of 2008 are imporan evens in our sample and had dramaic effecs on financial service firms. The rue long run response of dividend growh for financial firms, esimaed from a much larger sample wih less influence from financial crises, may be less dramaic han we show in he figure. This is especially rue if financial firms generally employ less leverage han was common immediaely before he financial crisis. 6 Figure 6 in Appendix B shows he impulse responses for addiional secors: Consumer Discreionary, Energy, Informaion Technology, Healh Care, Telecommunicaion Services, and Indusrials. These responses exhibi a similar paern: differences across indusries emerge over longer horizons. In paricular, Healh Care and Telecoms dividends exhibi a lower response in he long run relaive o Marke. The Indusrials dividend growh response more closely mirrors ha of he marke over longer horizons, alhough a a lower rae, Consumer Discreionary dividend growh is more responsive relaive o marke. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 5 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies Figure 3 plos he impulse response funcions for he wo sraegy porfolios, momenum (long/shor) and minimum volailiy. As wih he oher exhibis, he responses of he wo sraegy porfolios are compared o he marke porfolio. Again, quie pronounced differences wih he marke porfolio emerge over longer ime horizons. Jus like he value and small cap porfolios, boh minimum volailiy and momenum porfolios have a high long erm bea wih respec o rend growh. Wha is differen abou he wo sraegy porfolios, however, is he immediae shor erm effec a shock o rend growh of GDP has on dividend growh. In hese cases, a shock o rend growh leads o a relaively fas increase in dividend growh raes. In oher words, he wo sraegy porfolios seem o have a high bea o real economic growh over boh shor and long horizons. Figure 3: Sraegy Porfolios are Exposed o Economic Trend Growh Shocks. Impac (percenage) 7 6 5 4 3 2 1 0 0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 64 68 72 76 80 Horizon (Quarers) Barra USE3 Momenum Facor Marke MSCI USA Minimum Volailiy The char depics he cumulaive impac of a 1.5 percen permanen increase in real oupu on he Barra USE3 Momenum Facor porfolio, and he MSCI USA Minimum Volailiy Index, and he marke porfolio dividends. The impulse responses are based on quarerly daa for each porfolio dividends, real GDP, and real aggregae corporae profis, from 1998 o 2012. The final se of impulse response funcions are shown in Figure 4. This char plos he response of dividend growh in equiies and real esae condiioned on a shock o rend growh. Real esae cash flows are modeled here as lised real esae cash flows. As is eviden from Figure 4, equiy marke and real esae cash flows differ meaningfully in heir responses o shocks o rend growh, and hese 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 6 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies differences are eviden over boh shor and long horizons. This char can be inerpreed as saying ha real esae cash flows exhibi a higher economic exposure relaive o equiy cash flows. 7 Figure 4: Real Esae Exhibis High Sensiiviy o he Real Economy. Impac (Percenage) 16 14 12 10 8 6 4 2 0 0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 64 68 72 76 80 Real Esae Marke Horizon (Quarers) The Figure depics he cumulaive impac of a 1.5 percen permanen increase in real oupu on he MSCI USA Real Esae Index, and he Marke porfolio dividends. The impulse responses for Real Esae are based on quarerly daa for he MSCI USA Real Esae Index dividends, real GDP, and real aggregae corporae profis, from 1995 o 2012. Hisorically, he VAR Model Has Performed Well The premise of his paper is ha differen porfolios can exhibi differen cash flows in response o large, unusual shocks o he economy bu ha hese differences may only be observable over longer ime horizons. A reasonable quesion o ask is how well our VAR model fis he hisorical cash flow responses following large macro shocks. By definiion, large shocks do no occur frequenly. Moreover, our ineres is in he long period following he shocks. Consequenly, we are limied in he number of acual experiences ha we can use o validae he model using he available sample period. For he purposes of his paper, we will resric our comparison o he global economic shock experienced in 2008 and he four years following ha shock. Since he macroeconomic shock was 7 As for financial firms, he sample period of our daa may be imporan for real esae. Because our sample sars in 1995, i omis a prior collapse in real esae bu includes he period of he real esae bubble and is collapse around he ime of he 2008 global recession. Boh of hese effecs could raise our long erm correlaion esimaes beween real esae cash flows and he real economy beyond he level ha would be eviden wih a longer hisory. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 7 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies negaive, our model predics ha cash flow growh should also be negaive in he four year period following he shock. Figure 5 conrass he prediced change in cash flow growh wih he observed cash flow growh for he period 2008 2012. Figure 5: Acual Experience is in Line wih he Model. Realized/Forecas Dividend Growh (Percenage) 30 20 10 0 10 20 30 40 50 Marke Small Cap Large Cap Value Growh Uiliies Real Esae Maerials Financials Three year ahead dividend growh forecas condiional on he realized 2008Q3 shock o oupu Realized real dividend growh from 2008 Q4 o 2011Q4 The char compares, for each porfolio, is realized cumulaive dividend growh from 2008Q4 o 2011Q4, o he model forecased dividend growh, condiional on he realized shock o real oupu in 2008Q3. Figure 5 illusraes ha, for he mos par, acual cash flow growh was roughly in line wih he predicions of he VAR model. The model prediced ha dividend growh for he marke porfolio would be negaive, and i has been. Moreover, he model prediced ha small cap dividend growh would be worse han large cap dividend growh, and i has been. Finally, he model prediced ha a severe economic conracion would have adverse consequences for dividend growh in financials, which is in line wih acual experience. The bigges differences beween he model predicions and acual experience are in real esae, and growh versus value. For real esae, he model prediced a much larger decline in dividends han was acually realized. As discussed above, he real esae equaion may be sensiive o he choice of ime periods. And real dividends declined by abou 30 percen in he year following he shock o real oupu, followed by a maerial rebound hereafer as he real esae marke recovered. As for dividend growh in value and growh socks, he model prediced a much less dramaic swing han wha was acually 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 8 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies observed. The model prediced ha dividend growh for value would conrac, and dividend growh for growh would be neural. The acual experience was a much more significan conracion in dividend growh raes for value, and an expansion in dividend growh raes for growh. Overall, hough, i is fair o conclude ha he VAR model s predicions are mosly in line wih he realized values. Conclusion In his paper, we have focused on he impac of macroeconomic shocks o real oupu on porfolio cash flows. We have shown ha he response of porfolio cash flows o persisen shocks o GDP rend growh (our definiion of macro risk) can emerge over long ime horizons. Furhermore, we have shown ha he responses of various equiy porfolios o shocks o rend growh can be quie differen over long horizons, even hough here are few meaningful differences over shor horizons. Because here are meaningful differences in how asse cash flows respond o macro shocks, we would anicipae differences in long run reurns. In paricular, we would anicipae ha hose asses whose cash flows have a higher long run bea wih respec o economic rend growh should also have a higher long run reurn. As wih any oher reurn, he higher long run reurn for hese asses is compensaion for an undiversifiable risk in his case, he risk of a persisen shock o rend growh in real GDP. To more fully analyze he asse pricing and risk implicaions of shocks o rend growh, we mus complemen our analysis of asse cash flows wih a similar analysis of discoun facors. Discoun facors, long run reurns and implicaions for porfolio risk are he subjec of he nex paper in his series. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 9 of 16
Reference Marke Insigh Macro Sensiive Porfolio Sraegies Blanchard, Olivier Jean, and Danny Quah, 1989, The Dynamic Effecs of Aggregae Demand and Supply Disurbances. The American Economic Review, Vol. 79, No. 4, pp. 655 673. Campbell, John Y., and Tuomo Vuoleenaho, 2004, Bad Bea, Good Bea. The American Economic Review, Vol. 94, No. 5, pp. 1249 1275. Sims, Chris A., 1980a, Comparison of Inerwar and Poswar Business Cycles: Monearism Reconsidered. American Economic Review, Vol. 70, pp. 250 257. Sims, Chris A., 1980b, Macroeconomics and Realiy. Economerica, Vol. 48, pp. 1 48. Hansen, Lars P., John Heaon and Nan Li, 2008, Consumpion Srikes Back? Measuring Long Run Risk. Journal of Poliical Economy 116 (2), 260 302. Winkelmann, Kur, Ludger Henschel, Raghu Suryanarayanan, and Kaalin Varga, 2012, Macro Sensiive Porfolio Sraegies: How We Define Macroeconomic Risk. MSCI Marke Insigh, November 2012. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 10 of 16
Appendix A: Vecor Auoregressions (VARs) Marke Insigh Macro Sensiive Porfolio Sraegies Vecor auoregression models (VARs) are he common saisical ools used o capure and analyze he join evoluion over ime of muliple financial and economic variables. Definiion In heir mos general specificaion, each variable in he sysem is relaed o is lags, and he lags of all he oher variables. A VAR model wih n variables and p lags is expressed as: Y Y Y Y e (1) 1 1 2 1... p p where: Y conains he ime observaions for he n variables of ineres sacked below each oher. p is he number of lags. is he inercep and conains a differen value for each elemen of Y. are he n by n VAR coefficien marices. These marices give he sensiiviies of 1,..., k k p each variable o heir own lags and he lags of all he oher variables. For example, he firs row of each coefficien marix k gives he sensiiviies of he firs variable o is k h lag (firs column) and he k h lag of all he oher variables. More generally he i h row and j h column of k gives he sensiiviy of he i h variable in Y o he k h lag of he j h variable. e is he ime model residual and conains a differen value for each elemen of Y. We assume he model residual o be serially uncorrelaed over ime. Long run risk model for real oupu growh The long run risk model we use o idenify persisen shocks o real oupu growh also allows us o sudy he relaionship beween porfolio cash flows and he economy. Following Hansen, Heaon, and Li (2008), his model is a VAR wih wo lags and wo variables: he log of real oupu growh and he log of aggregae real corporae profis o real oupu raio. 8 Formally, we define he dependen variable in he VAR sysem as: where * g g 1 Y cp g g is he log of real GDP a ime, and (2) cp is he log of aggregae corporae profis a ime. 8 We replace he aggregae real consumpion series used in Hansen, Heaon, and Li (2008) by he real GDP series. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 11 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies The main moivaion for including he second variable is ha i capures a weak bu highly persisen componen o real oupu growh. Indeed, ( cp g) is highly and posiively correlaed wih is own lags. Thus, i helps o idenify he persisen shocks o real oupu growh we are ineresed in. Inegraing porfolio cash flow growh dynamics Following Hansen, Heaon, and Li (2008), we model he link beween porfolio cash flow growh and real GDP growh, by appending a paricular porfolio cash flow growh as a hird variable o he long run risk model (2): where * Y Y d d 1 d is he log of porfolio dividends. (3) Wih wo lags, our VAR model can be expressed as: Y my Y e (4) 1 1 2 2 In addiion, we impose he resricion ha porfolio dividends do no Granger cause real GDP and corporae profis. This means ha surprise changes o a paricular porfolio s dividends do no affec real GDP, nor aggregae corporae profis. On he oher hand, porfolio cash flow growh remain driven by surprise changes o he wo oher macro variables. We can implemen he Granger causaliy resricion by consraining he firs wo rows of he hird column of he coefficien marices ( k) k1,2 o be zero. Idenifying a persisen shock o real oupu growh VARs can be used o sudy he impac over ime of shocks o a given variable or a combinaion of variables on all variables in he dynamic sysem. In order o do his, however, one mus idenify he shocks of ineres. In our case, we wan o idenify hree shocks in he VAR, specified in equaion (4), such ha: One of he shocks capures a persisen shock o real oupu growh, as our focus is o sudy he impac of his persisen shock on porfolio cash flows. The second shock has only a ransiory effec on real oupu growh. The hird shock is a shock o he porfolio dividend growh, unrelaed o real GDP growh and corporae profis. All hree shocks each have a variance of one, and are uncorrelaed wih each oher, so ha we can measure he pure impac of each shock (say, he persisen shock). Unforunaely, he model residuals e hemselves are no he relevan candidaes. In paricular, hey do no saisfy he hird condiion, as he elemens of e are correlaed wih each oher, unless a resricion is imposed. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 12 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies However, we can find our shocks of ineres ( u ) o be linear combinaions of he model residuals. Tha is, u will be in he form: u Qe, (4) for an appropriaely chosen marix Q. One can show ha he following choice of Q fis he bill 9 : where: B ( ') 1 Q Chol B B B (5) 1 ( I 1 2), e e is he covariance marix of he VAR residuals e, A ' denoes he ranspose of a marix A, and Chol( A ) denoes he lower riangular marix in he Choleski decomposiion of marix A. Impulse responses Once he shocks of ineres have been idenified, we can assess he cumulaive impac of hese shocks on all variables in he sysem, a any horizon. I is convenien o re wrie he VAR in is sae space form: where: X AX u, (6) 1 1 Y m 1 2 Q X A Y 1 031 I 0 33 0 33 I denoes he ideniy marix and 0 n l denoes a n by l marix of zeros. The cumulaive impacs of shocks u o all he variables, a horizon h, can be compacly exraced from he firs hree rows and columns of h j 1 h A (7) j0 The firs column idenifies he impac of he persisen shock on all he variables in X. The second column idenifies impac of he ransiory shock. And he impac of he shock o porfolio dividend growh is given by he hird column. 9 This choice of Q is similar o one used by Blanchard and Quah (1988) o idenify supply and demand shocks in heir VAR model for real oupu and unemploymen. Their assumpion was ha demand shocks carry no long run effec on real oupu, while supply shocks may affec real GDP in boh he shor and he long run. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 13 of 16
Marke Insigh Macro Sensiive Porfolio Sraegies For example, he cumulaive impac of he persisen shock o real oupu growh on porfolio cash flow growh, a horizon h, is given by he hird row of he firs column of. h Impulse responses and long run risk dynamics The sae space represenaion (6) and he impulse responses given by (7) allow us o convenienly decompose he process for real oupu growh and porfolio cash flow growh in erms of a long run componen and a ransiory componen. Indeed, following Hansen, Heaon, and Li (2008), one can rewrie real (log) oupu and (log) porfolio cash flows as: g g g u gx 1 Long-Run Transiory d dd u dx 1 Long-Run Transiory (8) where g and d are he limiing impulse responses of real oupu and porfolio dividends o shocks u (impulse responses when he horizon is infinie): j1 j1 g g A d d A, j0 j0 wih g [1,0,0,0,0,0] and d [0,0,1,0,0,0] g and d are he mean real oupu growh and porfolio cash flow growh I A g g 1 ( ) and I A d d 1 ( ) are he sensiiviies o he ransiory sae X As ime () grows, and as he residuals u are serially uncorrelaed, he long run componen explains a larger fracion of he real oupu and cash flow growh risk. In his sense, g and d are measures of long run risk o real oupu and porfolio cash flow growh. Macro risk dominaes porfolio cash flow growh risk in he long run for hose porfolios ha are sensiive o persisen shocks o real oupu growh. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 14 of 16
Appendix B: Impac of a Shock o Real Oupu Trend Growh on Seleced MSCI Secor Index Dividends Marke Insigh Macro Sensiive Porfolio Sraegies Figure 6: Indusrials, Healh Care, and Telecoms Exhibi Lower Exposure o Trend Growh Shocks Relaive o Marke over Long Horizons. Impac (Percenage) 5 4 3 2 1 0 1 2 3 4 0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 64 68 72 76 80 Horizon (Quarers) Indusrials Healh Care Telecoms Marke Energy Consumer Discreionary Informaion Technology The char depics he cumulaive impac of a 1.5 percen permanen increase in real oupu on he MSCI USA Consumer Discreionary, Indusrials, Energy, Informaion Technology, Indusrials, Healh Care, Telecommunicaion Services Index, and he Marke porfolio dividends. The impulse responses are based on quarerly daa for each indusry porfolio dividends, real GDP and real aggregae corporae profis, from 1995 o 2012. 2013 MSCI Inc. All righs reserved. Please refer o he disclaimer a he end of his documen 15 of 16
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Please refer o he disclaimer a he end of his documen 16 of 16