Equities Risk

More details on economic factor mimicking portfolios

Synopsis

Here we present more details on the return characteristics of the factor mimicking portfolios designed to capture the influence of economic factors. The portfolios are formed every December by sorting the universe of All Ordinaries Index stocks into terciles based on their loadings on the factor of interest. Each stock's loadings are calculated via exponentially-weighted moving average time-series regressions over the previous five years with decay parameter λ = 0.95. The factor mimicking portfolio returns are the monthly return spread between the top tercile portfolio and the bottom tercile portfolio. Relative volatility is the ratio of the factor mimicking portfolio volatility to the volatility of the return spread of randomly assigned tercile portfolios.

Table 1. Return characteristics of economic factor mimicking portfolios.
Factor	Minimum	25th percentile	75th percentile	Maximum	Standard deviation	Relative volatility
Commodity beta	-0.186	-0.030	0.029	0.165	0.056	2.850
TWI beta	-0.196	-0.039	0.029	0.154	0.054	2.736
Market beta	-0.183	-0.036	0.028	0.167	0.052	2.627
Interest rate beta	-0.154	-0.026	0.022	0.091	0.038	1.919

Sensitivity to commodity prices, exchange rates and market returns appear to be strong drivers of return differentials in Australian equities. Sensitivity to interest rate changes appears to be relatively less important.

Factor mimicking portfolio total return indices

Commodity beta Factor mimicking portfolios — Figure 1. Total return indices of factor mimicking portfolios based on commodity beta.

Trade-weighted index beta Factor mimicking portfolios — Figure 2. Total return indices of factor mimicking portfolios based on TWI beta.

Market beta Factor mimicking portfolios — Figure 3. Total return indices of factor mimicking portfolios based on market beta.

Interest rate beta Factor mimicking portfolios — Figure 4. Total return indices of factor mimicking portfolios based on interest rate beta.

Commodity beta is the time-series loading on the Bloomberg Commodity Index return; TWI beta is the time-series loading on the return of the trade-weighted index of currencies against the AUD; Market beta is the time-series loading on the All Ordinaries Accumulation Index return; Interest rate beta is the time-series loading on changes in yield spread between 10-year and 2-year government bonds.