IFAs should stress test portfolio suitability: Walker Crips 07 December 2015

IFAs should stress test portfolio suitability: Walker Crips

Advisers are leaving a gap between outlining client objectives and detailing why a particular recommendation is suitable, with more rigorous stress testing of portfolios required, according to Walker Crips Investment Management.

Speaking to FTAdviser, portfolio manager Gary Waite argued that having an appreciation of how a portfolio or strategy performs under extreme stress is a valuable tool when assessing what gives a client the best chance of an optimal outcome.

He and fellow portfolio manager Andrew Morgan brought some of the methods from their institutional background at BlackRock to the recently-launched Alpha: r2 range of portfolios.

“Advisers rarely get calls when a clients’ portfolio is doing well; they are normally reserved for when markets turn sour.

“Stress testing can give real insight into whether a ‘defensive’ or ‘conservative’ portfolio is predicted to behave as you would expect it to - in advance of the actual event - such as the next financial crisis, terrorist attack or asset bubble.”

Mr Waite suggested that stress testing may well make the move from systemically important banks across to the wealth management industry.

“It’s the logical next step for the FCA to take in assessing suitability. Looking at portfolios through a risk lens is common practice at institutional asset managers and there is no good reason why it shouldn’t be replicated on the retail side.”

Steve McMahon, managing director of Asset Risk Consultants’ Jersey branch, agreed that understanding the reaction of a portfolio to a set of given events is important.

“You can test a diverse range of scenarios but history shows the biggest stresses come from unpredictable events, and in these scenarios asset classes rarely exhibit normal behaviour.”

He explained that the majority of managers ARC works with carry out some element of stress testing on their portfolios as part of their investment process, but that is only ever going to be part of a bigger picture, given the infinite number of factors; including covariance and correlations, manager selection issues, market pricing problems, etc.

“To defend against all of these elements conspiring against a portfolio, it’s important to see a well defined and trusted investment process that takes input from a diverse mix of high quality individuals, but its just as important to consider how the people managing the assets will react in times of market stress.”