Parametric investment management has become an increasingly popular technique in the investment industry. By utilizing statistical and quantitative analysis, it provides a more systematic approach to build optimized portfolios catered to clients’ specific needs. This article will explain what parametric investment management is, its key benefits, and how it can help investors better manage risks and improve returns through factor-based investing and smart beta strategies. We’ll also discuss some real-world applications and examples of parametric management in action from leading investment managers.
Parametric investment management leverages statistics and quant analysis to systematically construct optimized portfolios
At its core, parametric investment management relies heavily on statistics, econometrics, and quantitative analysis to systematically construct optimized investment portfolios. The key idea is to identify various factor exposures that drive risk and return, then calibrate these factor weights to build a portfolio that’s tailored to an investor’s specific objectives and constraints. This differs from traditional active management which depends more on subjective views. By taking a rules-based, parametric approach, investments can be selected and weighted in a more intentional, transparent manner to enhance diversification and risk-adjusted returns.
Factor investing allows investors to systematically target risk premia
A major component of parametric investing is factor-based strategies that target specific risk premia in a transparent, rules-based manner. Examples include size, value, momentum, quality, and low volatility factors. Investors can overweight factors that they believe will outperform over time. Parametric managers can screen for stocks with certain factor characteristics, then optimize factor exposures at the portfolio level. This provides a disciplined approach for harvesting factor premiums while managing risks.
Smart beta ETFs are a popular application of parametric investing principles
Smart beta ETFs have exploded in popularity in recent years as an application of parametric investing principles. These funds track alternative non-cap weighted indices designed to capture risk premia associated with certain factors. For example, a value index may screen for stocks with low price multiples and systematically overweight them. Smart beta provides a transparent, rules-based approach for targeting factors. Parametric managers can allocate to smart beta ETFs as building blocks to efficiently gain factor exposures while managing portfolio risks.
Parametric management enables customization for individual client needs
A key advantage of parametric investing is the ability to customize portfolios for individual clients based on their unique objectives, constraints, tax considerations etc. For large institutional investors like pensions, the manager can directly optimize at the total portfolio level. For individual clients, separately managed accounts can be created. Exposures can be tailored for specific needs, while trading directly in underlying securities provides greater tax efficiency.
Leading asset managers like BlackRock and Vanguard offer parametric strategies
Many large asset managers now provide parametric investing solutions. BlackRock’s Scientific Active Equity strategy uses quantitative models for factor exposures and portfolio optimization. Vanguard offers parametric separately managed accounts. Additional examples include Man Group, Bridgewater, AQR, and Nuveen. Parametric strategies are becoming popular for those seeking more systematic, customized portfolio management. As computing power and big data improve, adoption will likely continue growing.
In summary, parametric investment management provides a rules-based, quantitative approach to construct optimized portfolios catered to clients’ objectives. By leveraging factors and smart beta strategies in a transparent manner, it allows investors to systematically target risk premia and enhance diversification. With the ability to customize exposures, parametric investing enables more tailored solutions to meet individual needs.