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FRM Part II · FRM Exam Part II · Factor Theory

A risk manager reviewing a multi-asset fund notes that a large share of its risk premium comes from exposure to a single factor, which is the economic growth factor. Which action best improves diversification of macroeconomic factor risk?

The manager should add assets exposed to different macroeconomic factors, such as inflation-linked or nominal government bonds. Equity sectors and high-yield bonds still load mainly on economic growth, and leverage only scales the existing concentration rather than diversifying it.

  1. AAdd more equity sectors, since sector differences diversify growth risk
  2. BAdd assets with exposure to other macro factors, such as inflation-linked bonds or nominal government bondsCorrect
  3. CIncrease leverage on the existing equity holdings to raise the Sharpe ratio
  4. DReplace corporate bonds with high-yield bonds, which have lower growth sensitivity

Explanation

Equity sectors and high-yield bonds all load heavily on growth, so they do not diversify it. Assets tied to inflation or rates factors diversify the growth concentration. Leverage scales exposure but does not diversify it.

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