Better client outcomes through advanced portfolio projection

To offer clients a better tool for projecting possible investment outcomes, many portfolio projection models use Monte Carlo simulations to drive their results.

However, as discussed on our previous article, simplistic Monte Carlo simulations have shortcomings and may generate results that do not fully account for major economic and market shock events (such as COVID-19), and a rapidly evolving macroeconomic arena.

In an investment climate in which market shocks are dominant and the degree of uncertainty is very high, an advanced tool for generating and analyzing plausible risk–return scenarios is more important than ever. An ideal model would be adaptive and time varying, and thus be able to dynamically account for current market conditions and factor in uneven distributions of results in real time.

Introducing Economic Scenario Generators

A better portfolio projection model can offer more realistic and useful insights for advisors and their clients in changing market conditions. What should an advisor look for? An advanced probabilistic model is also known as an Economic Scenario Generator (“ESG"). Let’s take a closer look.

An ESG recognizes that past events and performance only represent one specific possible outcome. A robust ESG considers past events, but can repeatedly generate scenarios based on the effects of other possible outcomes. The main distinguishing value between an ESG-powered model and a Monte-Carlo-driven one is the quality of the underlying assumptions.

Unlike Monte Carlo models, ESG makes use of “stylized facts” based on real-world features and behavioral patterns of financial markets. Stylized facts include non-normal distributions of portfolio returns, tail risks, business cycle dynamics and time-varying risks and volatility. Factoring in these stylized facts can lead to more realistic scenarios and probabilities, which offer investors the following benefits:

• Scenario analysis that offers a full range of “more likely” and “less likely” outcomes
• A more detailed picture of risk–return tradeoffs
• Portfolio projection that can take future economic and market shocks into account
• Portfolio monitoring that can readjust probabilities and track portfolio progress based on significant changes in market and economic conditions.

In our next article in this series, we will leverage Ortec Finance’s expertise in building proprietary ESG-driven risk and return projection platforms to show how such solutions can be deployed as a strategic practice-building tools. For more information on advanced portfolio projection models, contact the Ortec Finance team. For more information on truly advanced client portfolio monitoring and goals-based planning, visit the OPAL Wealth page and download the product brochure. For any other questions or demo request, please contact Neil Greenbaum below.

Download the OPAL Wealth Brochure here