An Example

We conclude the section with an example of a risk decomposition as provided by Goldman Sachs' PACE system. Figure 20.4 shows the first page of a PACE Risk Monitor Summary report for a hypothetical portfolio as of December 31, 2001.

The report shows that the portfolio's value on this day is $488,481,650. Its benchmark portfolio (i.e., the portfolio that is used in calculating tracking error) is the S&P 500. This portfolio currently contains 106 assets and 2.63 percent of its total value is in cash. Looking at the left-hand side of the top box in this report, we see that its annualized predicted tracking error (US Predicted TE) is 4.81 percent. The target TE for this portfolio is 4.50 percent, so this portfolio is running slightly above target. For comparison, this report shows a predicted tracking error from an alternative model (US RMG Daily TE). According to this model, the predicted tracking error is 4.84 percent. Reading down, we come to a box called "Risk Decomposition." This information shows that about 49.94 percent of the risk is specific and the remaining (50.06 percent) is coming from factors. In particular, 23.04 percent and 27.02 percent of the total tracking error is attributed to industries and investment styles, respectively.

Continuing down the page, we come to a table that shows contribution to risk by asset (stock). These contributions are based on the RCTE calculations. For example, Intel is the highest contributing stock to tracking error. It consumes 7.14 percent of the overall risk budget and has an underweight (versus the benchmark) of 114 basis points. Similarly, Oracle is also an underweight (its ac-

FIGURE 20.4 Risk Decomposition Example

tive weight is negative 74 basis points), and it consumes 4.33 percent of the overall risk budget.

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