Uncertainty and Style Dynamics: Portfolios Under Construction

Global Markets Research
Quantitative
Strategy
Quantitative Strategy
North America United States
18 April 2012
Portfolios Under Construction
Uncertainty and Style

Dynamics
Uncertainty, style dynamics and factor rotation strategies
Reseach Summary
Uncertainty and episodic shifts in risk
appetite can rotate style factors towards
unwanted and even dangerous risk
profiles. We investigate the drivers and
dynamics behind these stealth rotations
and show how to monitor, control and
even profit from them.
Team Contacts
Miguel-A Alvarez
Risk appetite changes and involuntary style rotation

We perform a forensic analysis of recent factor behavior to show how sharp and
rapid shifts in risk appetite can rotate factors away from their steady state
compositions. Indeed, as we show in the case of Momentum these rotations can
unexpectedly position factors towards stocks that have been overbought and
away from stocks that have been severely oversold.
Vigilant monitoring and understanding factor dynamics
We propose a simple and effective way to monitor factor dynamics in the face of
uncertainty and strong changes in risk aversion. We also investigate style
dynamics in the past to analyze factor shifts in past episodes of market
uncertainty.
VRP to the rescue
We use the variance risk premium (VRP) to take a proactive stance in the face of
continuing macroeconomic uncertainty and recurring style shifts. We devise two
simple factor-timing strategies based on the VRP. We find these strategies to be
highly effective at switching; especially during episodes of shifting risk appetite
(risk-on/risk-off).
Strategist
(+1) 212 250-8983
miguel-a.alvarez@db.com
Yin Luo, CFA

Strategist
(+1) 212 250-8983
yin.luo@db.com
Rochester Cahan, CFA

Strategist
(+1) 212 250-8983
rochester.cahan@db.com
Javed Jussa
Strategist
(+1) 212 250-4117
javed.jussa@db.com
Zongye Chen
Strategist
(+1) 212 250-2293
john.chen@db.com
Sheng Wang
Strategist
( +1) 212 250-8983
sheng.wang@db.com
Deutsche Bank Securities Inc.

Note to U.S. investors: US regulators have not approved most foreign listed stock index futures and options for US investors.
Eligible investors may be able to get exposure through over-the-counter products. Deutsche Bank does and seeks to do
business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of
interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making
their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.MICA(P)
146/04/2011.
18 April 2012
Table of Contents
Letter to our readers ......................................................................... 3

Uncertainty continues............................................................................................................ 3
Risk appetite and style dynamics a recent synopsis ................... 4

Risk-on, risk-off and recent style dynamics ............................................................................... 4
Recent factor performance ....................................................................................................... 6
The Beta connection ................................................................................................................. 8
Factor Dynamics and Regimes ............................................................................................... 15
VRP and style rotation .................................................................... 16

Variance risk premium and risk appetite changes ................................................................... 16
Implementing the VRP strategy .............................................................................................. 18
VRP for style rotation .............................................................................................................. 19
References ........................................................................................ 23
Page 2
18 April 2012
Letter to our readers

Uncertainty continues
Last year saw a series of events that caused havoc for some investors, while others found
themselves well-positioned and outperformed. General consensus has it that 2011 saw a
reversal from past years, in that, quantitative investors generally outperformed while
fundamental managers struggled1.
Indeed, our own long/short equity QCD Model Portfolio 2 had an IR of 2.1 while the
performance of many conventional quantitative factors ended in positive territory in 2011.
The large cap universe was somewhat of a different story and while our factors did show
overall positive performance over 2011, the numbers were not nearly as robust as those
across the full spectrum of US stocks.
What actually happened in 2011? Why where quantitative factors working so robustly again
and what happened to quants in January 2012 when many saw significant drawdowns in
performance?
In this report, we aim to address these questions and much more. We will link much of the
outperformance of conventional quantitative factors over 2011, especially that corresponding
to the de-risking episode in the summer, to the outperformance of low Beta stocks and
significant underperformance of high Beta stocks during this period.
This low-risk outperformance during the summer and fall was driven by the de-risking episode
caused by a worsening of the European sovereign debt crisis. The crisis induced fears of
recession sending investors overwhelmingly towards safety and out of risk in which they piled
into quality and other low-risk stocks; while at the same time dumping riskier stocks.
We look at the effect of these de-risking and subsequent re-risking episodes not only in the
context of factor performance, but also on the dynamics underlying factor rotation. We will
see that aside from driving significant levels of performance, these episodes can reposition
factors and may sometimes make different factors across different style more correlated, or
driving some factors to take very concentrated risk exposures.
Lastly, we use the variance risk premium (VRP) together with the analysis on style factor
dynamics under changes in risk-appetite to devise two simple factor rotation schemes that is
adept at picking factors that will outperform during these episodes.
Thanks,
Yin, Rocky, Miguel, Javed, John & Sheng.
1
Our conversations with clients lead us to believe that performance across large cap quantitative funds was more
mixed than overall good.
2
See Luo et al, 2012 QCD Model: DB Quant Handbook for a detailed model methodology.
Page 3
18 April 2012
Risk appetite and style

dynamics a recent synopsis
Risk-on, risk-off and recent style dynamics
One of the determining drivers of investor risk appetite is economic sentiment. Therefore, the
enduring global macroeconomic instability and the uncertainty it propagates to financial
markets has been a major catalyst for the abrupt and sharp reversals experienced in risk
appetite since the financial crises. Indeed, risk-on/risk-off along with re-risking/de-risking
will be the defining labels for market behavior over this tumultuous period.
Measuring changes in risk-appetite
Risk appetite can be interpreted, loosely, as the demand for risky assets. Increases in risk
appetite corresponds to greater demand for risk causing prices of riskier assets to increase
relative to those of lower risk. Conversely, decreases in risk appetite generate greater
demand for lower risk assets and will cause their prices to increase relative to those of higher
risk. A simplistic yet effective means to quantify the demand for higher/lower risk is via the
return to a portfolio that is long high-risk stocks and short low-risk stocks. When risk appetite
increases, the return to this kind of portfolio should be positive, while periods of decreasing
risk appetite would generate negative portfolio returns.3 Stock risk can be measured in many
different ways, but a conventional means is to use stock Beta4.
Figure 1 shows the monthly and cumulative return to a portfolio that is long the top decile of
stocks ranked by Beta and short the bottom decile for our DBQS universe5 since January
2011. The figure also shows the return to the market capitalization portfolio which correlated
strongly with risk appetite especially during strong episodes of changing risk appetite.
Figure 1: US Monthly & Cumulative return to high minus low Beta Portfolio (Decile 10
minus Decile 1) and Market Portfolio (capitalization weighted), US DBQS universe.
20%
Monthly Return
15%
Beta (Q10-Q1 spread) Monthly Return (LHS)

Market Portfolio Monthly Return (LHS)
Beta (Q10-Q1 spread) Cumulative Return (RHS)
Market Portfolio Cumulative Return (RHS)
re-risking
50%
40%
30%
10%
20%
5%
10%
0%
0%
-5%
-10%
-10%
-20%
-15%
-20%
Cumulative Return
25%
-30%
de-risking
-40%
Source: Axioma, Russell, S&P, Deutsche Bank Quantitative Strategy
3
We are aware that this definition and characterization of the demand for risk is oversimplified. However, as we will
see, this characterization is sufficient to gauge risk preferences within the aggregate equity universe.
Page 4
Unless otherwise noted, we will use stock Predicted Beta from the Axioma medium horizon risk model.
Our DBQS universe is covers a similar universe to the Russell 3000.
18 April 2012
The negative returns to Beta and the market during August and September of 2011
correspond to sharp declines in risk appetite (aka de-risking) brought along in most part by
the worsening European risk landscape as Italian sovereign yields increased to dangerous
levels. The subsequent re-risking episodes in October and more recently in January
correspond to what many are calling a resolution to tail risk in Europe. While we are unsure
of the full resolution of Europes economic troubles, we do agree that the likelihood of a US
recession has decreased since the summer.
Last, we note from Figure 1 that positive returns to the market portfolio do not always
coincide with larger returns to higher Beta stocks, i.e., positive market return does not
necessarily translate to increases in risk appetite. Two good examples are April 2011 and
March 2012. A risk explanation for this phenomenon would lie in the generally accepted
notion that Beta is not the sole driver of systematic return. Fundamentally, it is the result of
the Market having a much larger Size bias than the Beta portfolio. Therefore, these episodes
can be interpreted as investors shifting towards Size in a stronger way than they are shifting
away from higher Beta.
Risk appetite in other markets
Outside the US, we find that risk appetite in the rest of the world had similar behavior during
2011 and beginning of 2012 (Figure 2).
Figure 2: Global ex-US Monthly & Cumulative return to high minus low Beta Portfolio
(D10 D1) and Market Portfolio (cap weighted), S&P BMI Global ex-US universe.
25%
Monthly Return
15%
10%
re-risking
40%
30%
20%
5%
10%
0%
0%
-5%
-10%
-10%
-20%
-15%
de-risking
-20%
Cumulative Return
20%
50%
Beta Monthly Return (RHS)
Market Portfolio (LHS)
Beta Cumulative Return (RHS)
Market Portfolio Cumulative Return (RHS)
-30%
-40%
Other measures of risk appetite

Another measure that is commonly used to look at risk appetite in general is the TED spread.
Many investors take the spread to be a fear index. It is simply the spread between Libor
and the three-month US Treasury Bill6. Higher levels of the TED spread are associated with
higher risk aversion (lower risk appetite) and vice versa. Therefore, we expect that changes in
the TED spread should be inversely related to the returns to the Beta portfolio. Figure 3 and
Figure 4 show that indeed the TED spread and the return to global Beta have a strong inverse
relationship.
http://www.wikinvest.com/rate/TED_Spread
Page 5
Figure 3: TED spread versus cumulative return to Global

Beta factor portfolio (D10-D1)
60
Figure 4: Changes in TED spread versus monthly return

to Global Beta factor portfolio (D10-D1)
20
10%
TED Spread
50
15
-10%
30
-20%
20
Change in TED Spread
TED Spread
40
Cumulative Return
0%
20%
TED (change)
Beta Monthly Return (RHS)
10
10%
5
0
0%
-5
-10
Monthly Return
18 April 2012
-10%
-30%
10
-15
Beta Cumulative Return

0
-40%
Source: Axioma, Russell, S&P, Bloomberg LLP, Deutsche Bank Quantitative Strategy
-20
-20%
Recent factor performance

What effect did the strong decrease in risk appetite during the summer 2011 have on style
factors? As uncertainty increases, investors will eventually trade off riskier stocks that may
not sustain their expected cash flows in a recession for more defensive stocks that are more
resistant to economic contractions. Sectors and industry matter, but we can also characterize
defensive stocks via style factors such as ROE, Dividend Yield and Earnings dispersion. For
practical purposes, we will analyze a subset of factors from our factor library which are
conventionally used to represent investment styles. The goal is not to analyze every factor,
but rather to analyze factor shifts arising from changes in risk-regime changes. Figure 5 lists
the styles and factors we will use in this analysis. In addition, unless otherwise noted, we will
work with decile spread portfolios.
Figure 5: Factors and styles
Style
Value
Momentum/Sentiment
Quality
Growth
Factor
Direction
FY1 Dividend Yield
FY1 Earnings Yield
Price-to-Book
--
Price-to-Sales
--
Momentum 12-month
Momentum 6-month
FY1 EPS Revisions
FY1 EPS Dispersion
--
ROE
YoY EPS Growth
EPS Growth (5yr)
Source: Deutsche Bank
Two factor categories during 2011

Based on the evolution of cumulative factor performance over 2011 and the beginning of
2012, a nave categorization detects two groups of factors. A first set (Figure 6) which
outperformed during the summer/fall de-risking episode, while underperforming during the
re-risking in October 2011 and subsequent to December 2011. The second set (Figure 7)
underperformed or were flat during the summer de-risking and slightly outperformed (or
were flat) during the subsequent re-risking episode. Other factors were mixed, which we
detail below.
Page 6
18 April 2012
Figure 6: Cumulative return outperforming factors

during the de-risking in summer 2011. Russell 1000
Figure 7: Cumulative return for under-performing

factors that during summer 2011. Russell 1000.
30%
Cumulative Return
20%
25%
FY1 EPS Dispersion

ROE
20%
Beta Monthly Return
25%
30%
FY1 Dividend Yield
Momentum
15%
10%
5%
Price-to-Sales
FY1 EPS Revision
YoY EPS Growth
15%
10%
5%
0%
0%
-5%
-5%
-10%
-10%
FY1 Earnings Yield
A closer look at factor performance in Figure 6 shows that the de-risking episode starting in
August generated significant gains for each of the factors with exception to 12-month
Momentum. Similarly, the factors depicted in Figure 6 underperformed during the re-risking
in October and subsequently in January and February of 2012.
Conversely, the factors depicted in Figure 7 showed to underperform during the de-risking
episodes, while outperforming (albeit slightly in the case of Earnings Revision) during the
episodes of re-risking. Figure 8 shows the performance to the other factors in our study. The
returns refer to the decile portfolio spreads.
Figure 8: Factor decile spread portfolio statistics over Jan 2011 Mar 2012
Factor
Average Return
ROE
Volatility
Sharpe Ratio
9.61%
5.90%
1.63
EPS Growth (5yr)
11.97%
10.11%
1.18
FY1 EPS Dispersion
13.85%
13.29%
1.04
Market
11.81%
15.79%
0.75
YoY EPS Growth
5.27%
8.46%
0.62
Momentum 12-month
5.01%
10.68%
0.47
FY1 Dividend Yield
5.73%
12.62%
0.45
Price-to-Sales
1.66%
11.35%
0.15
FY1 EPS Revisions
0.41%
4.68%
0.09
FY1 Earnings Yield
0.61%
7.75%
0.08
Momentum 6-month
-1.87%
20.38%
-0.09
Beta (D10-D1)
-13.73%
33.65%
-0.41
Price-to-Book
-6.59%
7.26%
-0.91
Is risk appetite driving factor performance?

In the last section, we saw how factor performance was strongly influenced by recent
episodes of re-risking and de-risking. To get a better sense of the link between factor
performance and recent changes in risk appetite, Figure 9 and Figure 10 compare the
monthly returns of a subset of factors to our risk-appetite factor, Beta. The negative (Figure 9)
and positive (Figure 10) correlation between the factors and Beta is evident; especially across
periods when risk appetite experiences strong changes (i.e. when the magnitude of the
return to Beta is large).
Page 7
30%
6%
4%
10%
2%
0%
0%
-2%
-10%
-4%
Predicted Beta (LHS)
FY1 Dividend Yield (RHS)
FY1 EPS Dispersion (RHS)
-6%
-8%
-30%
FY1 Div Yld, FY1 EPS Disp. Monthly Return
20%
Beta Monthly Return
30%
10%
8%
-20%
Figure 10: FY1 Earnings Yield & YoY EPS Growth versus
Beta return decile spreads. Russell 1000
-10%
10%
8%
20%
6%
4%
10%
2%
0%
0%
-2%
-10%
-4%
Predicted Beta (LHS)
-20%
-6%
FY1 Earnings Yield (RHS)
-8%
YoY EPS Growth (RHS)
-30%
FY1 Earn Yld, YoY EPS Growth Monthly Return
Figure 9: FY1 Dividend Yield and FY1 EPS Dispersion vs.

Beta return decile spreads, Russell 1000
Beta Monthly Return
18 April 2012
-10%
Figure 9 and Figure 10 show that during the summer of 2011 to early 2012, the comovement
between Beta and style factors was very strong. However, not all factors were linked in the
same way, i.e. the relationship between Beta and different factors seem to vary widely even
between factors representing the same styles. For example, Dividend Yield and Earnings
Yield are both considered to be Value factors, but their performance and their relationship
with Beta was very different during this period7. In the next section, we discuss how to
measure the relationship between a factor and Beta in an accurate and timely manner. This
will prove useful to determine ex-ante how certain style factors will perform during an
episode of de-risking or re-risking.
The Beta connection

In previous research, we have documented the link between Beta and style factors8. In those
studies, we found that style factors could possess an inherent exposure to Beta and pick up
significant exposure to Beta during certain market regimes or which could have adverse
effects on performance. Moreover, we found that this exposure was dynamic and could, at
times, have large and rapid shifts.
One of the more important findings in that research underlined the need to include crosssectional information when computing exposures and correlations across factors. This is
because the cross-sectional analysis provides a snapshot of the current factor composition
and does not depend solely on past data that could be stale depending on factor dynamics.
In the following analysis, we will use two cross-sectional measures to characterize the link of
a factor to Beta:
Portfolio Beta
Expected Correlation between the factor portfolio and the Beta portfolio
The first is simply the Beta of the factor portfolio and is computed in the typical manner, i.e.
the portfolio weighted average stock Beta. In general, the Beta of a portfolio lends insight in
that it will provide a sense of the direction of the comovement (positive Beta implies positive
comovement and vice versa). However, it is of little use for quantifying an accurate measure
of the co-dependency between two factors.
Page 8
In fact, many investors regard Dividend Yield more representative of Quality than Value.
See Alvarez et al, 2010, Portfolios Under Construction: Volatility=1/N.
18 April 2012
The second metric is a forward estimate of the correlation between the factor portfolio and
the Beta portfolio9. This measure is somewhat more involved and requires a stock covariance
matrix, but is essential if accuracy is the primary objective. The expected correlation measure
is quite powerful in that it yields timely and accurate forecasts of factor co-dependency. More
importantly, it is a useful tool for monitoring and understanding factor dynamics as well as for
applications in risk and portfolio construction.
In the following sections, we analyze the exposures and correlation of each of the style
factors to Beta. We will show how Beta affects the performance of the factors, but more
importantly how episodes of de-risking/re-risking dynamically rotate their risk exposures
profiles.
In addition, we will use the changes in factor correlations to Beta gain insight into the
interactions and dynamic relationships between the factors.
9
This can be generalized to factor scores in general (not just decile spread portfolios) as we showed in Alvarez et al,
2011 Reviving Momentum: Mission Impossible?
Page 9
18 April 2012
Value
Value factors did not exhibit similar cumulative performance during 2011-2012 (Figure 6 and
Figure 7). In this section, we shed more light on the role that Beta plays in driving the
divergence and convergence across Value style factor performance.
We begin with a simple synopsis covering the more recent period. The top graph in Figure 11
shows the expected correlation to Beta for different value factors during 2011-2012. The first
half of 2011 saw varying levels of correlation across the different Value factors. In addition,
the chart shows that FY1 Earnings Yield and Price-to-Book have significant shifts in their
correlation to Beta. With exception to FY1 Dividend Yield, the de-risking/re-risking episodes
during the summer and fall of 2011 cause a series of shifts in Beta correlations culminating in
convergence. These numbers suggests that the homogeneity between different value factors
can be quite dynamic over time and across varying market conditions.
But is Beta driving performance? The graph at the bottom of Figure 11 shows that Beta will
overwhelm factor performance when both the correlation to Beta and the magnitude of the
return of the Beta portfolio is significant. For example, note that during the first half of 2011
when Beta return magnitude was relatively low, there was not much consistency between
the correlations to Beta and factor performance. However, during the de-risking/re-risking
episodes in the second half of the year, Beta plays a more significant role in driving factor
performance. Also note the mixed performance during November and December 2011,
which saw relatively low magnitudes to the Beta portfolio returns.
Figure 11: Expected correlation with Beta (top chart) and performance (bottom
chart) between Value factors during 2011-2012. Russell 1000
Page 10
18 April 2012
If we analyze the past (Figure 12 through Figure 15), we find that the dynamic relationship
with Beta is a common theme across value factors. In addition, the exposures and
correlations to Beta can vary widely across value factors over different market regimes. Also
note that in contrast to the behavior in Figure 11, the Dividend Yield factor can actually
experience shifts in Beta exposure and correlation over time. For example, note that leading
into the Financial Crisis of 2008, the Dividend Yield factor became more correlated with
higher Beta stocks. This is due to the fact that the sell-off of risky stocks during this period
was so robust that it even penetrated dividend paying stocks mainly financial stocks that
had by that time become the riskier (higher Beta) of that group.
Figure 12: Portfolio Beta: FY1 Earnings Yield, FY1
Dividend Yield, Russell 1000
Figure 13: Expected Correlation with Beta: FY1 Earnings

Yield, FY1 Dividend Yield, Russell 1000
1.0
100%
FY1 Earnings Yield
Expected Correlation with Beta
Portfolio Beta
FY1 Earnings Yield
80%
FY1 Dividend Yield
0.5
0.0
-0.5
-1.0
-1.5
FY1 Dividend Yield
60%
40%
20%
0%
-20%
-40%
-60%
-80%
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
-100%
Jan-90
-2.0
Last, it is worthwhile to note that Figure 14 and Figure 15 lend insight into the relationship
between Price-to-Book and Price-to-Sales factors. The exposures and correlations show that
the two factors exhibit a similar Beta profile over time with exception to the period after the
technology bubble circa 2000 2003.
Figure 14: Portfolio Beta: Price-to-Book, Price-to-Sales.
Russell 1000
Figure 15: Expected Correlation with Beta: Price-toBook. Price-to-Sales, Russell 1000
1.0
100%
Price to Book
Price to Book
80%
Price to Sales
Portfolio Beta
0.5
0.0
-0.5
-1.0
-1.5
Price to Sales
60%
40%
20%
0%
-20%
-40%
-60%
-80%
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
-100%
Jan-90
-2.0
Page 11
18 April 2012
Momentum and Earnings Revisions

In past research, we documented how this behavior could cause these strategies to
accumulate overwhelming levels of exposure to Beta causing them to be vulnerable to strong
and rapid shifts in risk appetite10. In addition, the dynamic nature of these strategies do not
make them well suited to be analyzed from a time-series perspective and so cross-sectional
measures are paramount to understanding their exposure to risk-appetite over time.
A good illustration of their sensitivity to Beta can be seen during 2011-2012 depicted in
Figure 16. First, we note that the correlation to Beta dropped off a cliff during the de-risking
episodes in August and September for both 12-month Momentum and EPS Revisions. This
rapid and strong rotation set up the factors to severely underperform during the re-risking
episode in January 2012 as investors increased risk appetite buying oversold risky (high Beta)
stocks and selling off overbought safe (low Beta) stocks.
Figure 16: Expected correlation with Beta (top chart) and performance (bottom chart)
of Momentum/Sentiment factors (Decile Spread Portfolios). Russell 1000
Note that correlations were significant leading into the de-risking, both factors held up rather
well. This indicates that their non-Beta component (e.g. stock-specific component) had
positive performance over this period. Indeed, the correlation levels between 25-50%
indicate that Beta will account for only a quarter to half of the variability of returns. The
historical correlation to Beta of both factors (Figure 18) shows that both the 12-month
10
See Alvarez et al 2011, Reviving Momentum, Mission Impossible? and Alvarez et al 2010, Neutralization and
Beyond.
Page 12
18 April 2012
Momentum and FY1 EPS Revision factors had picked up on lower Beta stocks during the derisking in the summer of 2010. This helps explain the outperformance of these factors during
the slow de-risking in the beginning of 2011 as well as the flat performance during the
stronger de-risking in August and September of 2011.
Last we note that a historical analysis of Beta exposure and correlation of both factors (Figure
17 and Figure 18) show that both factors exhibit very similar profiles to Beta over time.
Indeed, this suggests that in aggregate, analyst revisions are strongly tied to past stock
return momentum.
Figure 17: Portfolio Beta: Momentum (12M) and FY1
EPS Revisions factors, Russell 1000
Figure 18: Expected Correlation with Beta: Momentum

(12M) and FY1 EPS Revisions factors, Russell 1000
1.5
100%
80%
1.0
0.0
-0.5
-1.0
-1.5
FY1 EPS Revision (3M Avg)

-2.0
60%
40%
20%
0%
-20%
-40%
-60%
FY1 EPS Revision

-80%
Momentum (12M)
Momentum (12M)
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-90
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
-100%
Jan-90
-2.5
Jan-91
Portfolio Beta
0.5
Quality
Typical factors used to characterize firm quality such as Return on Equity (ROE) and Earnings
Dispersion also varied to some extent over 2011 and early 2012, albeit factor performance for
this style was more heterogeneous than that found for Value.
Quality factors typically load up on safer assets with lower Beta and overall risk profiles. This
is evident when looking at the exposure and correlation to Beta of these factors over time
(Figure 19 and Figure 20).
Figure 19: Portfolio Beta: ROE, FY1 Earnings Dispersion
(3M Avg). Russell 1000
Figure 20: Expected Correlation with Beta: ROE, FY1

Earnings Dispersion (3M Avg). Russell 1000
100%
1.0
ROE
ROE
80%
FY1 EPS Dispersion
Portfolio Beta
0.5
0.0
-0.5
-1.0
-1.5
FY1 EPS Dispersion
60%
40%
20%
0%
-20%
-40%
-60%
-80%
-2.0
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Feb-12
Feb-11
Feb-10
Feb-09
Feb-08
Feb-07
Feb-06
Feb-05
Feb-04
Feb-03
Feb-02
Feb-01
Feb-00
Feb-99
Feb-98
Feb-97
Feb-96
Feb-95
Feb-94
Feb-93
Feb-92
Feb-91
Feb-90
-100%
However, the historical analysis reveals that these factors can also exhibit different and
varying Beta sensitivity over time. Indeed, the more recent period saw the correlation
between ROE and Beta to increase to relatively high levels.
Page 13
18 April 2012
Growth
Two factors commonly used to describe firm Growth are year-over-year EPS growth (YoY
EPS Growth) and five year EPS growth (EPS Growth 5yr.). Fundamentally, the two are similar
except that they try to capture different cycles. However, the Beta exposure and correlation
analysis shown in Figure 21 and Figure 22 show that the two can exhibit significantly
different risk profiles as measured by their exposure and correlation to Beta.
Figure 21: Portfolio Beta: YoY EPS Growth and 5yr EPS
Growth. Russell 1000
Figure 22: Expected Correlation with Beta: YoY EPS

Growth and 5yr EPS Growth. Russell 1000
100%
1.5
80%
0.5
0.0
-0.5
EPS GROWTH (5Yr)
-1.0
YoY EPS Growth
40%
20%
0%
-20%
-40%
-60%
EPS GROWTH (5Yr)
-80%
YoY EPS Growth
Page 14
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
-100%
Jan-90
-1.5
60%
Jan-90
Portfolio Beta
1.0
18 April 2012
Factor Dynamics and Regimes

We can also use the expected correlation to Beta measure to analyze factor dynamics by
comparing the Beta alignment across factors related by similar fundamental measures. For
example, the FY1 Earnings Yield factor analyzed in Figure 11 is a function of price and analyst
FY1 EPS estimates. Therefore, the factors increase in correlation during the beginning of
2011 may be due to either high Beta stocks becoming cheaper relative to lower Beta stocks
or to analyst increasing their estimates to higher Beta stocks. In addition, we can use the
Beta correlation to the trailing earnings yield factor (FY0 Earnings Yield) as an auxiliary
comparison metric.
We can infer from Figure 23 that the increase Beta alignment of the FY1 Earnings Yield factor
is mainly due to an increase in EPS revisions for higher Beta stocks as suggested by the
increasing correlation of the FY1 EPS Revision factor. Note that the moderately negative
returns to Beta may have also had a slight impact on the rise in the FY1 correlation is
suggested by the slight increase in the Beta correlation to the FY0 Earnings Yield factor11. Yet
another likely scenario is that higher Beta stocks did indeed increase their EPS relative to
lower Beta stocks.
Figure 23: Expected correlation between FY1 Earnings Yield, FY0 Earnings Yield and
FY1 EPS Revisions and performance of the Beta portfolio. Russell 1000
One last interesting bit of insight we can get from Figure 23 is to observe the Beta
correlations during the periods of strong de-risking and re-risking. Note that during August derisking episode; analyst began their downward revisions of higher Beta stocks so much that it
offset an increase the correlation that would happen naturally by strong de-risking episodes in
which higher Beta stocks experience stronger decreases in price and consequently making
them cheaper relative to their past (see Figure 13).
11
One last scenario is that Beta d
Page 15
18 April 2012
VRP and style rotation

Variance risk premium and risk appetite changes
A topical and recurring theme in our research is what academics have dubbed the variance
risk premium (VRP). Simply, the measure can be thought as the difference between market
implied variance and expected realized variance. As the name implies, the measure is
considered to be a premium for the risk embedded in asset markets and it has been shown
to have predicted power of equity market returns.
Indeed in our prior research12 on VRP, we have found that it has predictive power for equity
market timing, country rotation and for asset allocation. In this section, we explore its efficacy
for capturing strong and persistent changes in risk-appetite and show how to implement it for
market or Beta timing.
In addition, we will investigate its efficacy for timing style factors and propose two simple
strategies that use VRP to predict and select a set of style factors that outperform an equal
weighted factor benchmark.
Did VRP forecast changes in risk-appetite during 2011 and early 2012?
The strong and persistent changes in risk appetite experienced in the summer and fall of
2011 and early 2012 provide a good test environment in which to analyze the link between
VRP and risk appetite as well as its efficacy for market and Beta timing. Figure 24 overlays
the VRP estimate from the prior month over the monthly returns to the market and Beta
portfolios. The graph shows that VRP was able to forecast the Beta and Market portfolio
quite effectively over this period. In fact, there was only one month in 2011 when VRP got
the forecast completely wrong (August 2011).
Figure 24: VRP(t-1) versus Market and Beta (D10-D1) monthly return (DBQS universe)
A rolling correlation analysis over time (Figure 25) shows that the predictive power observed
in Figure 24 is consistent over time, albeit recent predictive power is much stronger than the
historical norm.
12
Page 16
See Luo et al, 2012, Quantitative Tactical Asset Allocation and Luo et al. 2012 New Insights in Country Rotation.
18 April 2012
Figure 25: Rolling 60-month correlation with one-month lagged VRP: Market and Beta
Portfolios (Decile 10 minus Decile 1). US DBQS universe.
Correlation with one-month lagged VRP
(60-month rolling window)
50%
40%
30%
20%
10%
0%
-10%
Market
-20%
Beta (D10-D1)
-30%
Jan-12
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
-40%
VRP as a proxy for macroeconomic risk

One strand of the literature on VRP suggests that it is a risk premium for the macroeconomic
uncertainty embedded in asset markets (see Londono, [2011] or Bansal and Yaron [2004]).
The predictive power for Market and Beta timing shown in Figure 25 lends credit to this
hypothesis in that VRP shows to be a good predictor of changes in risk appetite as measured
by the Beta and Market portfolios.
Another way we can verify the link between VRP and macroeconomic uncertainty is to link it
to stock return correlation and the systematic component of the cross sectional dispersion of
stock returns (aka the opportunity set). In a prior paper 13 , we showed how stock return
correlation was linked to systematic component of cross-sectional return dispersion as well
as macroeconomic uncertainty. Figure 26 and Figure 27 show both of these measures
against the volatility of VRP and suggest that VRP volatility is strongly related to other
measures we have shown are affected by macroeconomic uncertainty. Note that high VRP
volatility indicates high levels of uncertainty about market direction.
Figure 26: Volatility of VRP versus Relative Macro-
Figure 27: Volatility of VRP versus pairwise stock return

correlation within sectors (Russell 1000)
30
25
40%
20
35%
15
10
30%
5
Volatility of VRP (24-month rolling std)
45%
Relative Macro Oppotunity Set
Volatility of VRP (24-month rolling std)
30
60%
55%
25
50%
20
45%
40%
15
35%
30%
10
25%
5
20%
Median Pairwise Stock Correlation
related Opportunity Set. Russell 1000.
15%
0
25%
Volatility of VRP (24M Standard Deviation)

Volatility of VRP (24M Standard Deviation)
% Macro-related Opportunity Set
13
Median Pairwise Stock Correlation within Sectors (24-month window)

See Alvarez et al, 2012, Correlation and Consequences.
Page 17
18 April 2012
Implementing the VRP strategy

The results in the last sections suggest that VRP can be used for Beta and market timing
purposes. However, exactly how to use it in a strategy is not so clear. One question that
comes up is how much market or Beta exposure should one take given the level of VRP? In
the following we propose a scheme to use it in a market or Beta-timing context.
VRP is given in variance units so it is not directly a return forecast (alpha). Therefore, the trick
is to convert the VRP today to a forecast of return for the next period. Specifically, the goal is
to obtain the best forecast of forward return conditional on the current value of VRP. A simple
way to get this estimate is to use linear regression14. The dependent variable will be the
market return over t-1 to t and the independent variable is the value of VRP at time t-1 as
follows:
(1)
RM ,t = + RM ,VRPVRPt 1 + t
In this equation RM , t is the return to the market over t-1 to t; RM ,VRP is the beta of the
forward market return to the current value of VRP; the intercept, , captures the mean effect
of both variables; and t is a random error term.
To estimate the RM ,VRP and parameters in equation (1), we can simply use OLS15. Once
these parameters are estimated, then the forecast of the next period market return is:
(2)
R M , t +1 = + RM ,VRPVRPt
In practice, we will update our estimates RM ,VRP and every month so a realistic backtest
will follow the same practice. Now we have a realistic forecast of market return for each
month that can be used for market timing and asset allocation among other uses.
Scaling the forecast
For market timing purposes, it is desired that higher forecasts imply higher market allocation
and vice-versa. An intuitive strategy is to allocate to the market portfolio in proportion to the
forecasts so that our market weight Wt takes on the following form:
Wt = k R M , t + 1 .
where k is a constant that we will use to target a specific volatility or tracking error. Then to
rescale the forecasts we estimate the volatility of the strategy for k = 1 . We can do this
analytically through the model or empirically using a history of returns for the strategy for
k = 1 . To keep things simple, we use the latter and call it k =1 . Now we choose a volatility
target (or tracking error target) for the timing strategy Target , and set k to:
k =
Target
k = 1
So the weight set to the market portfolio for the timing strategy at time t is:
Wt =
Target
k = 1
R M , t + 1
In the next example, we set a volatility target of 2.5% annualized and run the timing strategy
on its own and then add it to the market portfolio.
14
Under certain assumptions, the regression estimate is optimal in the sense of being the linear unbiased estimator
with the minimum amount of estimation error.
15
The error does not satisfy all the properties for OLS optimal estimates, but we leave a more sophisticated model for a
future study. The idea is to see how implement the VRP timing strategy in practice.
Page 18
18 April 2012
Figure 28 shows the monthly returns to our VRP market timing strategy with a 2.5%
annualized volatility target, while Figure 29 shows the cumulative return of mixing the market
portfolio with the same strategy.16
Figure 28: VRP Market-timing strategy monthly return
(2.5% target annual volatility)
Figure 29: Market + VRP Market-timing strategy

cumulative return (VRP strategy run at 2.5% annual vol)
6%
400%
VRP Strategy with 2.5% annulized vol.
12 per. Mov. Avg. (VRP Strategy with 2.5% annulized vol.)
350%
4%
Market
Market + 2.5% Volatility of VRP Timing Strategy
Cumulative Return
Monthly Return
300%
2%
0%
250%
200%
150%
100%
-2%
50%
-4%
0%
Source: Russell, S&P, Bloomberg L.L.P., Deutsche Bank Quantitative Strategy
Source: Russell, S&P, Bloomberg L.L.P., Deutsche Bank Quantitative Strategy
Last we note that adding the VRP timing strategy to the market in a more optimal manner
requires the estimation of the covariance matrix between the timing strategy and the market
portfolio, which can be done analytically or empirically. Then a rigorous signal weighting
technique could be used to obtain an optimal mean-variance portfolio17
VRP for style rotation

As we saw in the last section, raw style factors may possess significant exposure to changes
in risk-appetite, which we argued can be proxied by the return to a portfolio that is long high
Beta and short low Beta stocks (i.e. Decile 10 minus Decile 1).
We also saw that the variance risk premium (VRP) is quite adept at forecasting significant
changes and reversals in investor risk appetite, especially during the past three years of
unprecedented economic uncertainty.
The latter two points suggest that VRP can be used for style-timing or style-rotation. If so, the
following question is whether it can only predict the Beta component implicit in style factors
or whether it can predict more. We leave the second question for a future report.
In this section we analyze VRPs potential for style-timing and develop a simple scheme using
our correlation analysis from the prior section. This scheme will be used to turn-on and turnoff factors. An upcoming report will develop a more rigorous style rotation algorithm using
VRP as well as other macroeconomic and capital market variables18.
Beta-Correlation and VRP for timing style factors
The results in the prior sections of this report suggest a simple scheme to time style factors
using their exposure and correlation to Beta. The basic idea is that style factors exhibiting a
positive expected correlation to Beta will have a tilt towards increasing risk appetite, while
factors with negative correlation to Beta will have a tilt towards decreasing risk appetite. Then
we simply use the VRP forecast to turn-on or turn-off the factors.
16
The estimates for the parameters in the model were computed using an expanding window.
17
See Luo et al, 2011 Robust Factor Models or Alvarez et al, 2011, Driving in the fast lane.
18
This will be an extension of our previous style rotation research and model (see Luo et al, 2010 Style Rotation).
Page 19
18 April 2012
The methodology for the style-timing scheme is outlined in the following 5 steps:
Step 1: Set each factor to the same risk level using the factor portfolio historical volatility or a
forecast from a risk model.
Step 2: Identify the expected correlation of each style factor to Beta.
Step 3: Divide style factors into two groups:
A bullish group, which consists of those having positive expected correlation
A bearish group consisting of those having negative expected correlation
Step 4: Use the VRP forecast to select the bullish or bearish group of factors. To do this we
center VRP by subtracting its mean over the last 12-months19. Then for positive values of
this centered VRP we select the bullish group of factors; conversely for negative VRP we
select the bearish set.
Step 5: Build two models for the weights to the selected group.
VRP-EW: equal weighted: equal weight all the factors in the group chosen in Step 3
VRP-CW: correlation weighted: weight factors selected in Step 3 in proportion to the
absolute value of their correlations
Note that the risk scaling in Step 1 ensures that a factor with very high volatility does not
dominate the model. We can also consider this to be a nave version of risk adjustment in the
absence of an optimizer.
The correlation weighted model will overweigh factors with higher correlation to Beta, which
is an implicit reference to those factors having greater implied alpha as referred to in our last
section.
Our benchmark will be the equally weighted factor combination of the all the factors,
EQWGT, which as we have documented in past research is not an easy benchmark to beat20.
The results of the three models over different periods are shown in Figure 30. The Sharpe
ratios show that over the full period the VRP-EW performs the best in risk-adjusted space.
The VRP-CW model shows similar performance to the benchmark (EQWGT) over the full
history, but significantly outperforms in subsequent periods, especially post 2009. In fact, the
performance subsequent to 2010 is significantly better for the correlation weighted model,
suggesting that level (not just the sign) of the correlation between factors is a strong
predictor of factor outperformance.
Last, we note that the volatility of the VRP-CW strategy is significantly larger than both other
strategies. This is because the VRP-CW model tends to load up heavily on factors with
higher/lower correlation to Beta given that we are targeting the Beat component of each of
the style factors.
19
The results are quite robust for different window lengths. Specifically, we tried an expanding window, 60, 48, 36 and
24 month windows and all showed similar results. We chose a 12-month window to capture faster dynamics at the cost
of higher turnover and possibly more error.
20
Page 20
See Luo et al, 2010, Portfolios Under Construction: Robust Factor Models.
18 April 2012
Figure 30: Style rotation results for three style rotation models
Period
Mean
(Annual)
EQWGT
Std. Dev.
(Annual)
VRP-EW VRP-CW
EQWGT
Sharpe
Ratios
VRP-EW VRP-CW
EQWGT VRP-EW VRP-CW
Jan 1992 Mar 2012
11%
11%
21%
21%
18%
42%
0.53
0.61
0.50
Jan 2000 Mar 2012
13%
16%
30%
24%
21%
47%
0.58
0.78
0.63
Jan 2007 Mar 2012
5%
16%
49%
18%
13%
44%
0.28
1.21
1.12
Jan 2009 Mar 2012
-6%
13%
56%
18%
12%
44%
-0.33
1.04
1.29
Jan 2010 Mar 2012
5%
13%
45%
14%
12%
26%
0.40
1.14
1.70
Figure 31 and Figure 32 show the return series to both VRP factor timing strategies. Note
that in risk adjusted terms, the VRP-EW factor timing strategy outperformed the VRP-CW
strategy. However, the more recent period shows that VRP-CW strategy significantly
outperformed the VRP-EW strategy. This implies that the level of Beta mattered more during
the more recent period. Indeed, this is consistent with both high correlations and higher
systematic cross-sectional dispersion (Figure 26 and Figure 27).
Figure 31: VRP-CW style rotation model
60%
Figure 32: VRP-EW style rotation model

30%
VRP_CORR
VRP_EW
12 per. Mov. Avg. (VRP_CORR)
12 per. Mov. Avg. (VRP_EW)
40%
20%
20%
10%
0%
0%
-20%
-10%
-40%
-20%
-60%
-30%
The weights to the factors given by the VRP-CW strategy since January 2009 are shown in
Figure 33. Note that the cells in blue indicate that the factor is turned off. The factors that are
turned on, range from yellow to red, depending on the intensity of the absolute value of the
correlation to Beta. Also note that the VRP-EW strategy has the same active factors shown in
the figure. The difference is that the VRP-EW strategy equally weights the active factors in
the model.
It is also worthwhile to note that Momentum has turned off during the more recent period.
More importantly, was turned off during the re-risking that hurt the factor in January 2012.
Similarly the models had turned off Momentum during the risk-rally in the spring of 2009; and
interestingly enough has only appeared episodically since January 2009. In contrast, Price-toBook and Price-to-Sales were turned on throughout most of 2009. These factors were ripe
for the re-risking that took place throughout that year since they had rotated towards higher
Beta stocks that were made cheap during the 2008 de-risking.
Finally Figure 34 shows the VRP-CW factor weights along with factor expected correlations
to Beta. If we compare with the last few months in Figure 33, we find that VRP has switched
more bearish sentiment as is illustrated above in Figure 24. It has switched its allocation
towards the more defensively positioned factors and styles such as Momentum and Quality.
Page 21
18 April 2012
Figure 33: Factor loadings for the VRP-CW model January 2009 March 2012
FY1 Earnings Yield
Price-to-Book
Price-to-Sales
Momentum (12M)
Momentum (6M)
ROE
FY1 EPS Dispersion
YoY EPS Growth
EPS GROWTH (5Yr)
FY1 EPS Revision
Jan-09
17%
15%
35%
28%
0%
0%
0%
0%
0%
6%
0%
Feb-09
20%
21%
31%
27%
0%
0%
0%
0%
0%
0%
0%
Mar-09
23%
13%
33%
31%
0%
0%
0%
0%
0%
0%
0%
Apr-09
22%
0%
41%
36%
0%
0%
0%
0%
0%
0%
0%
May-09
4%
0%
52%
44%
0%
0%
0%
0%
0%
0%
0%
Jun-09
0%
0%
53%
47%
0%
0%
0%
0%
0%
0%
0%
Jul-09
0%
0%
41%
38%
0%
22%
0%
0%
0%
0%
0%
Aug-09
0%
0%
37%
35%
0%
27%
0%
0%
0%
0%
0%
Sep-09
0%
0%
31%
29%
0%
40%
0%
0%
0%
0%
0%
Oct-09
0%
0%
28%
28%
0%
44%
0%
0%
0%
0%
0%
Nov-09
0%
0%
36%
31%
0%
33%
0%
0%
0%
0%
0%
Dec-09
11%
20%
0%
0%
0%
0%
21%
20%
18%
8%
2%

FY1 Earnings Yield
Price-to-Book
Price-to-Sales
Momentum (12M)
Momentum (6M)
ROE
FY1 EPS Dispersion
YoY EPS Growth
EPS GROWTH (5Yr)
FY1 EPS Revision
Jan-10
10%
20%
0%
0%
0%
0%
21%
20%
17%
8%
4%
Feb-10
12%
22%
0%
0%
0%
0%
23%
22%
17%
5%
0%
Mar-10
13%
19%
0%
0%
0%
0%
22%
22%
16%
9%
0%
Apr-10
15%
16%
0%
0%
0%
6%
20%
21%
16%
6%
0%
May-10
17%
18%
0%
0%
0%
0%
22%
23%
12%
8%
0%
Jun-10
16%
20%
0%
0%
0%
0%
22%
23%
6%
13%
0%
Jul-10
0%
0%
25%
27%
27%
0%
0%
0%
1%
0%
20%
Aug-10
17%
19%
0%
0%
0%
7%
20%
22%
0%
15%
0%
Sep-10
0%
0%
23%
23%
1%
0%
0%
0%
29%
0%
23%
Oct-10
0%
0%
17%
26%
0%
0%
0%
0%
35%
0%
23%
Nov-10
20%
12%
0%
0%
0%
17%
18%
20%
0%
13%
0%
Dec-10
0%
0%
28%
38%
4%
0%
0%
0%
29%
0%
0%

FY1 Earnings Yield
Price-to-Book
Price-to-Sales
Momentum (12M)
Momentum (6M)
ROE
FY1 EPS Dispersion
YoY EPS Growth
EPS GROWTH (5Yr)
FY1 EPS Revision
Jan-11
0.192028
0.178586
0
0
0
0
0.184169
0.200319
0
0.170959
0.073938
Feb-11
0
0
0.163218
0.202718
0.111048
0.294686
0
0
0.22833
0
0
Mar-11
0.236637
0.148297
0
0
0
0
0.177604
0.246433
0
0.191029
0
Apr-11
0.311962
0.019851
0.03068
0
0
0
0.1555
0.312195
0
0.169812
0
May-11
0.331006
0
0.088089
0
0
0
0.134873
0.315973
0
0.130059
0
Jun-11
0.36996
0
0.135135
0
0
0
0.084403
0.340666
0
0.069836
0
Jul-11
0.400082
0
0.239542
0.032063
0
0
0.013361
0.314953
0
0
0
Aug-11
0
0.165365
0
0.095594
0.229961
0
0
0
0.243417
0.00668
0.258983
Sep-11
0.285303
0
0
0
0
0.202833
0.162924
0.271174
0
0.077767
0
Oct-11
0
0.279379
0.166944
0.286247
0
0
0
0
0.267429
0
0
Nov-11
0
0.212653
0.155782
0.274596
0
0
0
0
0.356969
0
0
Dec-11
Jan-12 Feb-12 Mar-12
0.14783
0
0
0
0 0.217863 0.220262 0.222494
0 0.242979 0.229495 0.294093
0 0.264078 0.276759 0.357995
0.150566
0
0
0
0.163803
0
0
0
0.118958
0
0
0
0.156504
0
0
0
0 0.27508 0.273484 0.125418
0.12725
0
0
0
0.135089
0
0
0
Factors and correlations for April 2012

The VRP-CW implied factors weights and the expected factor correlations with Beta are
shown in Figure 34 for April 2012. The weights suggest that the 12-month centered VRP
factor has taken on a slight bearish sentiment (see Figure 24).
Figure 34: VRP-CW factor weights and expected Beta correlations for April 2012
25%
20%
Weights for April 2012
80%
20%
20%
71%
Correlations
59%
60%
45%
19%
40%
35%
17%
15%
Weight
13%
10%
10%
Correlation
20%
0%
-6%
-20%
-40%
-45%
-60%
5%
1%
0%
0%
0%
0%
-58%
-80%
-75%
-84%
0%
-100%
-90%
-91%
Page 22
18 April 2012
References
Alvarez, M., Luo, Y., Cahan, R., Jussa, J., Chen, J., [2010], Portfolios Under Construction:
Volatility=1/N, Deutsche Bank Quantitative Strategy, June 16, 2010.
Alvarez, M., Kassam, A., Mesomeris, S. [2010], Factor Neutralization and Beyond,
Deutsche Bank Quantitative Strategy, September 21, 2010.
Driving in the fast lane, Deutsche Bank Quantitative Strategy, April 26, 2011.
Alvarez, M., Luo, Y., Cahan, R., Jussa, J., Chen, J., [2011], Signal Processing: Reviving
Momentum: Mission Impossible?, July 6, 2011.
Correlation and Consequences, January 24, 2012.
Bansal, R., Khatchatrian, V., and Yaron, A., 2005, Interpretable Asset Markets?, European
Economic Review, Vol. 49.
Luo et al, 2010, QCD Model: DB Quant Handbook, Deutsche Bank Quantitative Strategy,
22 July 2010.
Luo, Y., Cahan, R., Jussa, J. Alvarez, M., [2010], Signal Processing: Style Rotation,
Deutsche Bank Quantitative Strategy, September 7, 2010.
Luo, Y., Cahan, R., Jussa, J. Alvarez, M., [2011], Portfolios Under Construction: Robust
Factor Modeling, Deutsche Bank Quantitative Strategy, January 21, 2011.
Luo, Y., Cahan, R., Jussa, J. Alvarez, M., Chen, J., [2011], Signal Processing: Quant Tactical
Asset Allocation (QTAA), Deutsche Bank Quantitative Strategy, September 19, 2011.
Luo, Y., Cahan, R., Jussa, J. Alvarez, M., Chen, J., Sheng, W., [2012], Signal Processing:
New Insights in Country Rotation, Deutsche Bank Quantitative Strategy, September 2012.
Londono, J.M., (2011), The Variance Risk Premium Around the World, FRB International
Finance Discussion Paper No. 1035, available at SSRN: http://ssrn.com/abstract=2009065
Page 23
18 April 2012
Appendix 1
Important Disclosures
Additional information available upon request
For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see
the most recently published company report or visit our global disclosure look-up page on our website at
http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr.
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the
undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in
this report. Miguel-A Alvarez/Yin Luo/Rochester Cahan/Javed Jussa/Zongye Chen/Sheng Wang
Hypothetical Disclaimer
Backtested, hypothetical or simulated performance results have inherent limitations. Unlike an actual performance record
based on trading actual client portfolios, simulated results are achieved by means of the retroactive application of a
backtested model itself designed with the benefit of hindsight. Taking into account historical events the backtesting of
performance also differs from actual account performance because an actual investment strategy may be adjusted any time,
for any reason, including a response to material, economic or market factors. The backtested performance includes
hypothetical results that do not reflect the reinvestment of dividends and other earnings or the deduction of advisory fees,
brokerage or other commissions, and any other expenses that a client would have paid or actually paid. No representation is
made that any trading strategy or account will or is likely to achieve profits or losses similar to those shown. Alternative
modeling techniques or assumptions might produce significantly different results and prove to be more appropriate. Past
hypothetical backtest results are neither an indicator nor guarantee of future returns. Actual results will vary, perhaps
materially, from the analysis.
Page 24
18 April 2012
Regulatory Disclosures
1. Important Additional Conflict Disclosures
Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the
Disclosures Lookup and Legal tabs. Investors are strongly encouraged to review this information before investing.
2. Short-Term Trade Ideas

Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent
or inconsistent with Deutsche Banks existing longer term ratings. These trade ideas can be found at the SOLAR link at
http://gm.db.com.
3. Country-Specific Disclosures
Australia & New Zealand: This research, and any access to it, is intended only for wholesale clients within the meaning of
the Australian Corporations Act and New Zealand Financial Advisors Act respectively.
EU
countries:
Disclosures
relating
to
our
obligations
under
MiFiD
can
be
found
at
http://www.globalmarkets.db.com/riskdisclosures.
Japan: Disclosures under the Financial Instruments and Exchange Law: Company name Deutsche Securities Inc.
Registration number Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho)
No. 117. Member of associations: JSDA, Type II Financial Instruments Firms Association, The Financial Futures Association of
Japan, Japan Securities Investment Advisers Association. Commissions and risks involved in stock transactions for stock
transactions, we charge stock commissions and consumption tax by multiplying the transaction amount by the commission
rate agreed with each customer. Stock transactions can lead to losses as a result of share price fluctuations and other factors.
Transactions in foreign stocks can lead to additional losses stemming from foreign exchange fluctuations. Moodys,
Standard & Poors, and Fitch mentioned in this report are not registered credit rating agencies in Japan unless Japan or
Nippon is specifically designated in the name of the entity.
Russia: This information, interpretation and opinions submitted herein are not in the context of, and do not constitute, any
appraisal or evaluation activity requiring a license in the Russian Federation.
Page 25

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