Have You been stress tested?

Posted by Mike H on 25 July 2016 | Comments

(No, not by your children!)

We recurrently hear about banks etc. being “stressed tested” by regulators since the GFC.

Well now we have investment products offering to test portfolio resilience. The packages seem to be directed only to investment advisors in the USA at present. At this stage I suspect that their marketing is probably outperforming their research on likely validity.(I wonder if their algorithms include suggestions for a market with record low bond rates, equities/assets losing touch with their fundamentals and paying banks to take your money.)

Model portfolios confidently appear on a regular basis with magic percentages beside each category, often quite different to the preceding models. Most are guided by general rules of thumb. Surefootedly working out how they perform under different stressors is another matter.

Even without being able to use such products at present, I found the approach of this article is a useful way of reviewing portfolio diversity.

The blog link:

https://www.kitces.com/blog/stress-testing-a-diversified-portfolio-to-properly-evaluate-risk-exposure/

PS On a lighter side
You will be pleased to know I am also working on a technique to “stress test” a portfolio without the expense of a computer aided program.

  • To start with, I bundle my investments into sectors.

(Morning Star has a tool called Portfolio X-ray that uncovers your portfolio’s underlying exposure to various investment classes and it is available free.) So far so good!

  • Then I do a thorough “Strength, Weaknesses, Opportunities, Threats “analysis for each equity and sector, dealing with all sovereign, central bank, currency, inflation, interest rate, market sentiment risks, debt exposure etc. etc. I then give them a weighted scoring

(score each -10 to +10)

  • Next, I estimate the likelihood of these risks and opportunities occurring individually and in various logical clusters. I then give a score for the level of severity of each eventuality.

(score each -5 to +5 and multiply together)

  • Now I make estimate on how long these stressors and opportunities may last, both individually and in likely sequential clusters

(score 1-15 years+)

  • I ask what impact each scenario will have on both income and capital in each of these possibilities for each equity, sector and the portfolio as a whole.

(score -5 to +-5 for each, add together and divide by the number you first thought of.)

  • Ask one final question. What crucial factors have I overlooked? (optional)
  • By turning these estimates into scores I can now confidently pretend that they are much more reliable. If I then find an academic who will design an equation to link all these variables, I am sure they can then be regarded as totally trustworthy.

While I agree it does need work, my new manual technique is showing a lot of promise. I am definitely getting stressed.

Perhaps I need a holiday. See you at the conference.

 

Regards

Mike H

PPS

Sorry, I couldn’t find any blog site on how to best manage your children stress testing you!

 

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