A new dawn for risk profiling: introducing Synaptic Risk Explorer

Synaptic is launching a risk profiling solution, Risk Explorer, as part of a new Pathways suite of tools. Risk Explorer is aimed at firms looking to use risk to improve the advice they give, conquer the challenges of modern compliance, improve their businesses, and establish more efficient and repeatable methods of working.

A businessman working on a laptop

"The Moody's model provides metrics for loss and for growth, meaning that reliable inputs are always available for financial planners, whose management of 'informed consent' with clients will always be simple and credible."

We developed the Risk Explorer capabilities to close the gap within existing risk tools available on the market, including access to a full range of Synaptic data and MPS portfolios. The Pathways platform will have ongoing releases to bring in new capabilities, including removing the need to perform expensive additional MiFID II reporting by automatically delivering comprehensive ex-ante and ex-post reports with full disclosure. In this edition, we focus on the first feature of Pathways, the Risk Explorer.

We are making bold claims, however the development of Pathways and Risk Explorer is underpinned with extensive user testing and market research in the changing landscape. MiFID II is uncompromising about suitability and risk. Our insight was the opportunity to provide the retail advice sector access to the finest institutional-grade research and methodology. Most risk propositions reference Moody's research into their models, however Risk Explorer is the only tool to provide complete access to the Moody's stochastic engine, ensuring that objective, repeatable and reliable risk profiling can be performed.

Similarly, risk ratings tend to include qualitative overlays by analysts. In contrast, Synaptic follows Moody's approach of removing these distortions of 'qualitative overlays', which should remain within the domain of the firm, relying instead on the mathematical performance attributes of the asset classes under consideration. There is no way to maintain objectivity unless quantitative and qualitative are both considered. They are equally important of course, but should be treated separately. Synaptic hands off to RSMR for much of the qualitative research accessed through our tool set, whilst owning the automated, model-driven 'quant' analysis for our customers – we think, the best of both worlds.

Pile of regulation documents

Above is one of a series of documents from the regulator explaining the central role of suitability in advice.

What has changed?

Risk has always been a hot potato. When Rory Percival published his influential report on Risk Profiling in 2017, there were a lot of concerns raised regarding the role of risk profiling in the modern age, and the reliance on 'tools'. We believe our solution has answered all of these concerns and promoted the role of independent research in general. Regulation requires a robust framework, but it is equally important that the experience and knowledge of advisers is not eclipsed. A good research tool helps evidence the adviser's expertise, not dictate outcomes. This is what advisers mean when they refer to risk profiling as the 'basis of the conversation', and Risk Explorer takes the role of illustrating a range of outcomes, on the basis that comparison is an important part of achieving the correct fit. Risk profiling customers only works if there is a transparent and reliable mapping to an investment strategy via asset allocation, and this is where Moody's is peerless.

Risk profiling is entirely the responsibility of the adviser and is an integral part of suitability, increasingly identified by FCA directives as the main proof point, along with value (for suitability). As firms take increasing responsibility for the custody arrangements of funds under advice, their liability for things that could go wrong increases. The determination of the regulator to enforce suitability is constantly increasing, with warnings of more Thematic Reviews down the line.

"This use of a Value at Risk (or VAR) metric sidesteps the significant issues that reside with the more common use of volatility as a proxy for risk. Investors are interested in returns."

Moody's Analytics and Risk

Risk in investment terms equates to loss, and must be quantified to have any meaning (a medium tolerance for loss is meaningless without comparative values). It is impossible to predict the future, but mathematical models have been built that can ascribe probability with great accuracy. It is through the crisis of 2008, and more recently, that the reliability of stochastic modelling has been recognised by advisers. That's not to say that all stochastic modelling is great as it's not, but Moody's are exceptional. (Their 'forecast' for a 1 in 20 year loss on an adventurous portfolio, for example, mirrored the exact extent of losses from those portfolios in 2008 (the Great Financial Crisis), namely 23.5% over a rolling 12-month period, the insight which is what their 'Value at Risk' or Min gain' metric offers. 24% was the Min gain value ascribed to the Adventurous risk category in the in the Moody's investment strategy at the time).

The Moody's Economic Scenario Generator models economic conditions across the globe and is able to provide probability-based forecasts for asset classes that can be mapped to client's portfolios. To capture the full extent of 'viable' outcomes for investments, a mathematical simulation is done, on top of the rules within the engine, capturing the full power of a probability-based model. Thus, there is not an assumption for interest rates or inflation as 'capital market assumption' as in some models, the whole range of variables is modelled and outcomes are presented in a probability-based graph, that can be easily understood, including by clients. The Moody's model provides metrics for loss and for growth, meaning that reliable inputs are always available for financial planners, whose management of 'informed consent' with clients will always be simple and credible. An audit trail will always support any recommendation.

Efficient Frontier

Efficient Frontier chart

Example of results of a simulation performed by Moody's to map the outcomes of thousands of possible investment scenarios, to plot the 'efficient frontier' between risk and reward.

Cash 60%
UK Corporate Bonds 30%
Property 0%
UK Equity 5%
Global Equity ex UK 5%
US Equity 0%
Emerging Markets Equity 0%

What else is Synaptic offering?

Reduced MiFID research and reporting

  • Automated ex-ante and ex-post illustrations that are required for suitability as a means of fulfilling obligations around disclosure.
  • Including the full costs and charges analysis and the target market analysis.
  • No need to perform additional manual expensive and time-consuming MiFID II reporting.

Access to MPS discretionary portfolio data

  • This is made possible by the collation of data by the Synaptic research team to populate the reports. In addition to comprehensive data from Providers, Platforms and Funds (accurate to share class), Synaptic now collects data on discretionary managed portfolios, not previously available to standalone research tools.
  • This includes asset allocation data necessary for risk profiling, costs and charges data used for accurate illustrations and target market data for compliance purposes. If Risk Explorer is used in conjunction with Synaptic Comparator, the firm will be able to do the full range of projections, including accurate costs to explore the role of investment risk on behalf of the client.

New and improved Portfolio Building area

  • Ease of creation, import or export of portfolios, access to portfolios by 'Investment Pathways': I.D.D. (Insured portfolio), Discretionary Portfolios, Model Portfolios, Bespoke Portfolios, Multi Asset Funds, Unitised Funds;
  • Automatic, 'on-the-fly' risk profiling of portfolios by asset allocation using Moody's model driven rating of Asset Allocation.

Screenshot showing functionality of Synaptic Suite software

Table above shows the configurability of the new Synaptic suite and the Investment Pathways available in Risk Explorer on the right.

Illustrate the relationship between risk and investment term

  • Synaptic Risk Explorer is also designed to illustrate the relationship between investment risk and term, both of which are fundamental to considerations of Capacity for Loss. A well-defined, dynamic asset allocation model underpins investment decisions.
  • The Moody's model provides tables and graphs showing the likely outcome of any real or notional investment scenario, including the impact of increasing or decreasing term. There is a short questionnaire included to audit the adviser's exploration of the appropriate term commitment made by the client.

Summary of what you can do with Risk Explorer

Full risk governance

Built around the regulator's requirement for proof of suitability using the classic risk governance model, combining:

  1. Client's risk profile.
  2. Need to take risk.
  3. Capacity for Loss.

Built in ATRQ

From A2R which can be deployed across multiple devices, remotely, with clients or in paper format.

Strategic asset allocations

Map your clients' risk profiles to strategic asset allocations maintained by Moody's Analytics

  • Transparent risk model with simple boundaries for mapping, in 1-5 or 1-10 strategy;

    Any portfolio can be mapped using Moody's Value at Risk metric, at 95% certainty for losses in worst year of 20-year sequence:

    Cautious up to 7.5% losses in a bad year (1 in 20)
    Moderately Cautious up to 12.5% losses in a bad year (1 in 20)
    Balanced up to 17.5% losses in a bad year (1 in 20)
    Moderately Adventurous up to 22.5% losses in a bad year (1 in 20)
    Adventurous up to 27.5% losses in a bad year (1 in 20)

Project investment outcomes – gain and loss in one profile for any investment

The Moody's model provides the 2 key metrics for effective compliance and financial planning:

  1. Likely outcome on a probability basis for any investment scenario for which an asset allocation is available;
  2. Profile possible investment loss as the extent a portfolio is likely to lose in a bad year (in a 20 year term), allowing for accurate and meaningful alignment of an investment strategy to of a client, within a plan, based on their Capacity for Loss and risk profile. This use of a Value at Risk (or VAR) metric sidesteps the significant issues that reside with the more common use of volatility as a proxy for risk. Investors are interested in returns.

Quantitative approach to investment risk profiling

What makes this approach unique is that a purely objective, model-driven assessment that avoids any qualitative overlay, a shortcoming of most risk rating systems which depend on analysts' assessments. This means that the growth and potential loss metrics can be dealt with apart from the myriad of qualitative considerations that may influence an investment recommendation. This means that a genuinely repeatable and robust methodology can be applied, as required by regulation.

How does this fit into the wider mission for Synaptic?

"What makes this approach unique is that a purely objective, model driven assessment that avoids any qualitative overlay, a shortcoming of most risk rating systems which depend on analysts' assessments."

Risk Explorer is the first release of Pathways platform. Future releases will provide full integration of the Synaptic platform and product layer to allow a full range of research and client facing illustrations to be initiated from one place. This will also allow complete control within the firm for product governance and creation and deployment of C.I.P. and C.R.P.

Prompted by regulation, we believe that one of the key roles that firms are looking to fulfil is product governance. The MiFID II and PROD rules are uncompromising about the due diligence that is required to match segments, or client types with suitable investment solutions. Where this departs from the past is that due diligence needs to be delivered at proposition level, not on a case-by-case basis (that is left to the suitability assessment). Synaptic has designed an automated, friction-free process with access to all the relevant data.

What should firms do next?

There will be an opportunity for existing Synaptic customers to test drive Synaptic Risk Explorer. Any firm wishing to assess the capabilities of the new software can arrange a trial by contacting us on 0800 783 4477 or email hello@synaptic.co.uk