Risk exposed

With WealthBench, investors and their advisers are better prepared to face portfolio danger.

Risk matters. That is clear enough after a year of high market volatility, steep market declines and high-flyers like Enron and WorldCom crashing to earth. In the wake of such stormy market conditions, risk is at the forefront of investors’ minds. To serve today’s nervous client base, financial advisers must be able to identify, measure, and incorporate risk into every aspect of the wealth management process. Advisers, many of whom are new to thinking rigorously about risk, are facing increasingly difficult risk management questions. What are the best practices in risk-aware financial planning? What kind of risk matters most, and how do I measure it? How should I use risk information in designing a portfolio for a client? To help advisers incorporate risk into every step of the wealth management process, RiskMetrics Group has developed WealthBench™. WealthBench is a complete wealth management platform, incorporating:

• risk measurement and management
• goals-based wealth projection for strategic asset allocation
• tactical security selection consistent with a strategic asset mix
• monitoring and alerts to ensure consistency between the long-term plan and the actualportfolio. WealthBench embodies best practices in the design of each module and their interaction to meet all of the client’s financial planning needs. The components of WealthBench are as follows. The risk module The foundation of WealthBench is the risk module. It begins with RiskMetrics Group’s RiskGrades™, a standardised volatility measure that allows a dynamic “apples to apples” comparison of market risk across all asset classes and geographical regions. RiskGrades are available for individual assets and portfolios. Investors can use them to:
• measure overall portfolio volatility
• measure how much volatility a particular asset contributes to the portfolio
• quantify portfolio diversification benefits. In addition to RiskGrades, the risk module also includes a powerful stress testing engine that captures event risk. Investors can measure:
• expected losses on a typical bad market day
• expected losses in historical stress scenarios (such as Black Monday or the Asian crisis)
• expected losses in arbitrary, user-specified events (such as a steep decline in technology stocks or a change in the USD-JPY exchange rate). The risk module provides a broad picture of risk, one that goes well beyond a single volatility number. Long-term planning The financial planning process starts with a strategic asset allocation. WealthBench facilitates the construction of an asset class mix through its long-term wealth simulation engine, which projects the results of investing in a given portfolio or set of portfolios. The projection is custom-tailored to each individual, incorporating:
• taxable, tax-deferred, and tax-exempt vehicles, incorporating the appropriate tax rules in each case
• current and future income and expenses
• portfolio turnover
• the individual’s financial goals. Long-term portfolio return scenarios are generated from portfolio volatilities calculated by the risk engine. Taking these scenarios and the user’s financial data as inputs, WealthBench projects wealth over a specified time horizon and estimates the likelihood of meeting the stated goals. This gives individuals a picture of their most important risk: the risk of failing to provide for future needs. Advisers can use WealthBench’s strategic asset allocation module to select a long-term plan for their clients. This module identifies the plan with the best long-term performance, as measured by the wealth projection. Advisers and clients can choose long-term strategies that maximise:
• expected wealth at plan end
• probability of meeting a particular goal
• probability of meeting several goals at once. WealthBench also includes risk profiling functionality, which ensures that the selected asset mix is in line with the user’s ability to tolerate short-term market swings. Asset selection A long-term plan is only as good as its implementation. Once a plan has been chosen, advisers and users can use WealthBench’s tactical asset selector to construct a portfolio that implements the plan. The asset selector chooses from a list of candidate securities, which advisers or users specify. The choice is made so that:
• portfolio composition at the asset class or sector level matches the long-term strategy
• the portfolio tracks the returns of the long-term strategy
• the portfolio is optimally diversified. Monitoring and Alerts Portfolio characteristics evolve over time. For example, the asset allocation can change if stocks give higher returns than bonds, in which case a larger proportion of the portfolio will be concentrated in stocks. In addition, market volatility can change in time and the portfolio constituents can become more or less risky. WealthBench provides a monitoring and reporting module that identifies:
• portfolios that have drifted from the plan
• portfolios that may be at increased risk from market events (such as rising interest rates). Advisers can customise alert criteria and triggers. Along with alerts, the module generates proposals for remedial action. Alerts can be routed via e-mail or wireless messaging to advisers, clients or internal audit departments. Proven Methodology The institutional asset management community has a long and well-respected heritage in managing risk. WealthBench leverages institutional experience to bring a comprehensive suite of road-tested, institutional-quality tools to the desktop of the financial advisor. The risk management methodology at the heart of WealthBench, pioneered by RiskMetrics Group, has been an industry standard for well over a decade. The Monte Carlo simulation and optimisation techniques used in asset allocation and security selection draw on years of research experience by academics and practitioners. Client Value WealthBench offers advisers powerful utilities for client management. Even more importantly, it provides a unique opportunity to enhance the adviser-client relationship. Advisers who sit down with clients to discuss and analyse portfolio risk are rewarded with a better knowledge of client needs. Conversely, clients value the education knowledgeable advisers can offer them. WealthBench, with its broad suite of analytics, and its ability to compare portfolios based on these analytics, can facilitate discussion and mutual understanding. Making sense of the risk landscape is not easy, and advisers who can act as trustworthy and comprehensive guides will always be at a premium.