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Will Kinlaw, managing director and head of portfolio and risk management research at State Street Global Markets

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State Street launches index to help manage market risk in portfolios

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State Street Global Markets has launched its Systemic Risk Index, an index that measures the US equity market’s vulnerability to market shocks.

The index describes the degree to which a small number of macro risk factors, as opposed to stock- or industry-specific news, can drive stock returns.

The components of the index, covering the US equity market, are made up of approximately 60 industrial sectors.

The index provides a single, daily measure of fragility and can help portfolio managers to determine when they should consider hedging their portfolios or change investment strategies.

The index can be used in conjunction with State Street’s Turbulence Indices because it can provide an early signal of the onset of “unusualness” in the marketplace. Unusualness is defined as the covariance-adjusted distance between that day’s observation, which is comprised of a set of contemporaneous returns, and the multivariate mean in multi-dimensional space. Turbulence is defined using this multivariate distance to quantify unusual patterns of investment returns.

The index captures the extent to which markets are unified or tightly coupled. A tightly coupled market is driven by a relatively small number of macro risk factors and can be highly sensitive to negative news, such as economic announcements or new regulations. When markets are tightly coupled, they are more fragile because negative shocks spread more quickly and broadly. Conversely, when markets are loosely linked and less fragile, these negative shocks may be isolated to specific industries or sectors.
 
“In today’s market, investors are continually looking for new ways to manage risk in their portfolios,” says Will Kinlaw, managing director and head of portfolio and risk management research at State Street Global Markets. “State Street’s Systemic Risk Index is designed to provide institutional investors with an early indication of fragility within the US market so that they can adjust their strategies accordingly and maximize returns even in a difficult market environment.”

The index was developed by State Street Associates in collaboration with Windham Capital Management, a Boston-based investment management boutique.

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