The current range of economic challenges makes a strong argument for the ‘end of times’, but here's how to offer some perspective about how we might approach the task of stewardship of our clients’ investments.
I will make some observations to push back against the doom and gloom and restore some faith in the engine that has driven western economies to an unprecedented level of prosperity and value. The top companies in the S&P indexes have valuations in the trillions, and for good reason.
The job of investment advisers is to capture the asymmetric returns of the market. As long as the market functions, there will be asymmetric returns, and as historic data shows, we have sustained much worse than this before.
The changes, that began with RDR and the advent of new technology, promoted replacement business and the explosive growth of platforms, are relatively recent. The current situation is only the second crisis in the period of these systemic changes.
So what are the principles for surviving and thriving?
Investment is not speculation
Even reading the trades, certainly the financial pages in the press, there is a sense of impending doom for investors, as if investors were speculators. They are not. It may look like fun to run a hedge fund, but clients don’t need advisers to find their way to the casino. Investment is a mathematical exercise, practiced over the long term, requiring robust research and asset allocation discipline. It should not be governed by hunches or reliance on timing the markets.
Ignore the analysts of doom and gloom
This sounds like rule one, but I’m trying to make a slightly different point here. The majority of retail risk analysis is just that. Asset allocation and risk management in our industry has been controlled by a small number of analysts who are providing ‘qualitative’ insights into the behaviour of asset classes, holding firms hostage to opinions that are probably not that much more reliable than their own convictions. Any risk rating that is based on qualitative assessment will be overly susceptible to human error. What you need are stochastic forecasts (simulation), using proven models.
Trust the markets
If you don’t trust the markets you shouldn’t be invested. What is important is the continued functioning of the market in a manner that we can study over a century’s worth of data. We have learnt the value of diversification in portfolios and observed the overall trend for growth, which is what investment is set up to capture. Yes, markets experience turmoil, supply chains break and industries go through cycles, but we retain our faith in the market. The regulator has created a very sensible framework for advice that insists that no losses should exceed those that a client is ready and willing to able to take. Capacity for Loss is directly proportionate to term, and a client’s investment horizon must always allow for the expectation of losses in the short term. It is essential to stay invested, at a level of risk where any losses would not bring financial stress in the short term.
Synaptic has a full integration with Moody’s Analytics stochastic engine, giving access to projections to all the main asset classes appropriate for use in a portfolio as well as rules that define their interaction in a dynamic model, updated every quarter. It is the only retail offering to do so. Whereas, many institutions rely on the risk modelling and forecasting ability of Moody’s (famously Royal London and Standard Life) Synaptic offers the only tool to provide advisers and firms direct access. This means that unlike our competitors, you are relying on a purely mathematically model, providing probability-based outcomes that clients can understand and that have proven to be extremely accurate when reviewed historically.
A great opportunity to assess this was in the Great Financial Crisis of 2008. Phil Mowbray (Moody’s Analytics, formerly Barrie + Hibbert) wrote a paper ‘Did we spot a black swan? Stochastic Modelling in wealth management’. In short, Phil presents the numbers to evidence that Moody’s had attributed a realistic level of risk to the events of that fateful episode, and advisers who had relied on Moody’s would have set realistic expectations with clients of losses sustained and of subsequent growth trends. The 2008 crisis did not fundamentally challenge the underlying assumptions in the Moody’s model. Phil also observed that less reliable stochastic and other risk-based models that sought to flatter advisers did not fare so well. He concluded that ‘an unrealistic model will lead to unsuitable advice’. Moody’s was a valuable guide to navigating the 2008 downturn and our belief is that the model will continue to provide the most reliable forecasts going forward.
The Moody’s model has many fine attributes related to its overall forecasting, but its ability to support firms’ investment strategies centres on two key metrics; firstly ‘expected growth’ – this can be discerned for all core asset classes, funds or portfolios and is essential for any financial planning or cost considerations; secondly; a metric from the mathematical simulation that underpins the forecasts known as the ‘min gain’, identifying the extent of losses that can be expected in the ‘worst year’ of a 20-year term.
This latter can be calculated for any portfolio, and is the most objective (free of analyst opinion) measure for risk available to firms. Usefully, as an antidote to knee-jerk reaction to short-term bad news, the min gain value is a ‘Value at Risk’ metric over 12 months (rolling). So drawdowns, scary though they might be, are not given undue consideration, with the focus remaining on trends.
The markets are in turmoil as I write this, and are likely to be for some time. However, our assessment is that the long-term trends that the Moody’s model tracks are intact, and that in retrospect, Moody’s will have categorised risk accurately. Firms that built their investment strategies on the Moody’s model will almost certainly be able to demonstrate greater control over their clients’ investment outcomes and will have been able to coach their clients more successfully than those reliant on analysts. Another key attribute of the Moody’s stochastic approach is the ability to model inflation, way beyond the linear assumptions of lesser methodologies. The combination of Moody’s and Synaptic’s range of research assets in a single easy-to-use integrated package makes Synaptic Pathways the ultimate resource for firms during a crisis in the markets, but for all other times too.
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