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Embrace Market Uncertainty to Improve Your Investment Process

Yannis Sardis, 23 February 2021

“The essence of investment management is the management of risks, not the management of returns.”
Benjamin Graham, Economist and Father of Value Investing (1894-1976)

Extreme, Black Swan, market events are more frequent than commonly thought of and their effects can be devastating and long-lasting across all aspects of life.
In financial markets, investors cannot consistently predict market reckonings and re-allocate capital into non-affected assets in advance. The mission of all involved in asset management is not to predict the future but to manage positions of high conviction within a disciplined risk framework. Portfolio performance should be diligently risk-adjusted to create a range of portfolio rebalancing scenarios for a wide spectrum of unexpected market shocks.

Manage your Risk-Adjusted Performance

As we repeatedly discuss with our clients and prospects, investors should continually assess their wealth’s vulnerability to future price fluctuations, by stress-testing the loss-tolerance of their multi-asset portfolios for unexpected changes in stock price volatility and FX, interest rate curve and credit rating shifts, and cross-asset correlations. Such a process can be facilitated via the use of smart software solutions which allow investors and advisors to apply pre-determined investment principles and avoid decision-making driven by human biases.

In our modern world, the necessity of a holistic approach to risk assessment is amplified by the growing number of diversified investment vehicles, fund types and less liquid alternative asset pools such as derivatives, private equity, private debt, real estate, and tailored structured products. The ability to implement a multi-faceted portfolio risk analysis enhances a manager’s confidence about the capital adequacy that an investment strategy or a firm need to retain in order to cover significant losses in detrimental market conditions.

We should allow neither the prolonged monetary easing employed by the world’s central banks decrease our sharpness and investment’ reflexes, nor the feeling of missing out a market rally lead us to short-sightedness and long-term lapse of memory.

Market Risks in the eye of the beholder

We cannot predict the size and timing of the next financial crisis, but we can mitigate the various portfolio risks via disciplined and systematic risk-adjusted considerations. Our experience shows that such a framework would benefit various teams within a firm in their efforts to assess how such risks can influence their line of business, namely:

  • Portfolio Managers, who wish to be aware of how extreme market events and volatility spikes can impact the valuation of the firm’s investment strategies
  • Relationship Managers, who need to give clients a holistic portfolio management outcome, providing risk-adjusted performance and valuation figures
  • Risk Officers, who want to assess the market risk that a firm is exposed to, through predictive ex-ante risk metrics and advanced stress-testing scenario analytics
  • Compliance Officers, who want to ensure that the group’s trading activity conforms with its pre-determined investment policies and regulatory requirements
  • Executives, who want to decompose the firm’s client portfolios or internally managed funds and gain visibility to the market segments that expose it to the biggest risks.

We should embrace constructive change and have adverse market events make us improve our investment decision-making process and adaptive practices.

FINVENT Software Solutions is a trusted provider of advanced financial software applications and custom engineering services. The award-winning KlarityRisk platform specializes in investment risk analytics and fixed income performance attribution reporting and it is offered to Private Wealth institutions, Asset and Hedge Fund Managers and Family Offices. Finvent is the sole SS&C Advent distributor worldwide and its products are integrated with those of SS&C Advent. Finvent is also a partner of FactSet, the integrated data aggregator platform.