Investment risk management within the advice process using stochastic projections
Synaptic Modeller forms part of the Synaptic Research Suite for professional advisers, assisting in financial planning, risk analysis and reporting.
Any advisory firm looking to control risk within their investment recommendation processes should consider the several key differentiators that are offered within this module:
- Contains Moody’s Analytics stochastic engine –projects multiple investment outcomes to create a probability based model
- Provides access to a fully integrated Attitude to Risk Questionnaire
- Is fully integrated within the Synaptic Research Suite with access to the portfolio management system. Allows research to be undertaken using data relating to actual holdings as well as notional investments
- Is built around the FCA concept of ‘Capacity for Loss’ and is able to provide an objective measurement for investment risk
- Was created in response to the lack of objective risk related research available to advisers. Typically, research is subject to ‘qualitative overlay’ (‘opinion’ in other words), applied to volatility analysis. Stochastic projections offer a robust qualitative measure
- Research methodology is built around an ability to track investment through term and facilitate ongoing review
- Helps advisers work with the challenge that investment returns vary, and need to be balanced with risk over time. Synaptic Modeller helps ensure that advisers acquire ‘informed’ consent from clients by using meaningful and consistent measurements of risk – a key requirement for establishing suitability
- Most sophisticated risk analysis tool available to professional advisers, presented in an easy to use format.
The FCA and investment suitability
The FSA/ FCA made establishing ‘suitability’ of investment central to the RDR requirements. The FCA has stated that a professional adviser must:
- Know and understand the financial circumstances of their client
- Use a robust process to establish their client’s Attitude to Risk and Capacity for Loss
- Understand why they are recommending a certain Asset Allocation (strategy)
- Understand how the funds recommended satisfy the strategy
- Understand the tools they use to arrive at these decisions
- Review the strategy on a regular basis.
The FCA has stated that not only should a client understand:
- What their attitude to risk means and agree with it
- Understand what their ‘Capacity for Loss’ may be
- Quantify possible losses
- Assess client’s ability to absorb falls in the value of their investments.
Synaptic Modeller assists the adviser in meeting and evidencing the FCA requirements relating to client and investment risk and suitability.
The ‘Capacity for Loss’ Quotient
Synaptic Modeller calculates a Capacity for Loss ‘quotient’ – which is used as a consistent measure for risk. It is equivalent to the probability of achieving one of the 5% poorest investment outcomes as defined by the stochastic model, using the investment parameters, term and asset allocation as inputs.
This facilitates the following conversation:
“Mr. Client. Our model shows that during your ten year investment term, you have a 5% chance of gaining over 20% in any year, but also losing up to 10% of your portfolio in any year. Does this present an acceptable level of risk to you?”
The FCA has highlighted the risks of poorly implemented solutions, especially the lack of accuracy that can result from tools that are not correctly aligned. Modeller mitigates against these problems by providing integration with other tools in the Synaptic Research suite, facilitating the full investment advice process.
The image below shows projection for the strategic asset allocation for the Moderately Adventurous risk category. Indicated also are the ‘Minimum gain’ or ‘Capacity for Loss’ figure.
Investment Holdings and Goals
Synaptic Modeller will treat investment objectives as separate goals in line with FCA requirements. Different investment objectives may have different plans or accounts attached to them, and attract different risk exposure. The full range of client holdings and goals are accessible within Synaptic Modeller.
Image shows holding within a client record. Valuations are updated via new contract enquiry Messaging Hub.
The Attitude to Risk Questionnaire
Synaptic Modeller offers the option for advisers to select a risk profile either as a default or aligned to a specific investment objective. This is done manually or using the inbuilt questionnaire. The latter can be customized, or used in its default settings. Each risk profile is aligned to a set of strategic asset allocations within Synaptic Modeller, which in turn are aligned to the Moody’s risk model. Completed questionnaires can be saved against the client record.
Image shows built in Attitude to Risk Questionnaire. This is aligned with Synaptic Modeller’s Strategic Asset Allocations and investment strategy.
Capturing your investment strategy
Many firms prefer to use the default, or Synaptic Modeller investment strategy whose integrity is endorsed by Moody’s. The alternative is to create and publish your firm’s own investment strategy, defining attitude to risk levels, strategic asset allocation and risk category boundaries. The latter will require an advisory firm to produce their own research based assumptions.
Calculating the ‘Capacity for Loss’ Quotient using the stochastic engine
Having set up or recalled an investment goal, the adviser can undertake any kind of projection based research on behalf of the client, either using existing holdings or setting up new ‘what if’ scenarios.
Image shows ‘work space’ where parameters can be adjusted to test different outcomes.
Results and Reporting
As with all Synaptic tools, full reporting and audit trail is included. In Synaptic Modeller, ‘quick reports’ can be accessed throughout, or a full report that captures the full range of options considered and recommendations made.
The screenshots below show the results page, with risk and return profiles relating to different scenarios, represented in graph form.
Below is an extract from a Synaptic Modeller report.
As well as Synaptic Modeller, you may wish to consider the following for your business:
Synaptic Risk Rating – a free service including integrated Attitude to Risk Service
Synaptic Comparator – on and off platform price comparisons including Reduction in Yield Calculations, investment switching incorporating ‘Critical Yield’ and ‘Maturity value’ calculators, ‘Proxy Funds’ and flexibility for capturing full range of product and adviser charges.
Synaptic Webline – Protection and Annuities quote and e-apply portal. Soon to incorporate ‘Features Driven Quotes’