wealth management and asset allocation tools
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Asset Allocation and Stochastic ModellingEffective use in financial planning
Introduction
• Decline in guaranteed products changes the emphasis of advice
– Clients need good investment advice
– And they need it explained to them
• Asset allocation is the most important investment decision
• Decisions on long term asset allocation are always based on some sort of model
– Investments are uncertain
– So mathematical models are stochastic
Individual investors with institutional problems
• As defined benefit products disappear, investment risk becomes more important for retirement planning
• Responsibility falls to advisers
• That means
– Making good decisions
– Making sure investors understand
• Fortunately faster computers, the internet and the market allow
– Institutional solutions for individual investors
Decisions and explanations
• Advice process typically involves– Needs analysis
– Risk profile (ATR)
– Product selection (Asset allocation)
• In moving from needs to product solutions, we need to
– Explain risk to investor
– Compare alternative strategies
– Decide on a course of action
– Monitor and update
• We can help do this
For long term investors high equity exposure doesn’t mean high risk
Fund Profile Modelling and portfolio efficiency
But in the short term cash can be king
With income drawdown you can be too cautious
With profits vs. unit linked
Where do these comparisons come from?
• A model!
• What does a model need to do– Forecast outcomes – need sensible returns
– Range of outcomes – need a stochastic model
– Range of assets – need a multi asset model
– Global markets – need currency and global model
– Retirement planning – need annuity prices and interest rates
– Real understanding – real terms results need inflation forecast
• It’s a complex world that’s being modelled
Many models are available
• Our tools aren’t tied to a particular model
• But, any model that meets the requirements from the previous slides will be complex
• Our stochastic model Global CAP:Link meets these requirements and more….
• Actually built for a greater list of requirements
• In development for over 15 years
• Originally used for institutional asset and liability management
• Cheaper computers mean it can now be used for retail investors
Global CAP:Link – main relationships
Short & Long Interest Rates and Full Treasury Yield Curve
Price Inflation
Equity Earnings Yield
Equity Earnings
Growth Rate
Cash & Treasury Bond
Income and Total Return
Equity Income and Total
Return
Real GDP
Currency Strength
Global CAP:Link – relationships extended
Derived Asset Classes, e.g. property, small cap equities, etc
Derived Asset Classes, e.g. property, small cap equities, etc
CoreCore
Wage InflationWage
InflationAdditionalInflation
AdditionalInflation
Aa Corporate
Yield Curve
Aa Corporate
Yield CurveB
CorporateYield Curve
B Corporate
Yield Curve
Index-Linked
Yield Curve
Index-Linked
Yield Curve
Additional GDP
Additional GDP
Additional Economic VariablesAdditional Yield Curves
Japan UK & Europe
U.S.A
Other Countries
And made global
Key Links Are:
• Currencies
• Bond yields
• Earnings yields
Global CAP:Link – how is it built?
• Start with the relationships it needs to model
• Write down equations which capture those relationships
drt = f1(ru - rt)dt + f2(rt, pt,…)dt + f3(rt)dZ1
• Calibrate parameters to match
– Historical data
– Current market conditions
• Test the calibration and its implications for the required purposes
Obtaining results from the model – theory
• Model determines a distribution of future outcomes for the economy and the market
• There is no simple formula for the distribution
• But an equation is what is needed for a Monte Carlo calculation
• A set of scenarios can be generated that matches the equation and calculates outcomes for an investment product or strategy
• From these outcomes, a range, average, maximum, as appropriate, can be determined
CAP:Link in practice
• Calibration updated quarterly
• Agreed with
– Historical record
– Current market
– Regulators (FSA etc.)
• Scenarios generated off-line in advance
• Number of scenarios and modelled assets are produced as required for each deployment
• Holistic product range taking account of assets, contributions, income, fees/charges, tax and guarantees
New challenges for any model
• Side by side comparison of variable annuities to help decide between products
– Range of funds is a key consideration so need to capture fine distinctions between funds in a systematic way
– Also need links to:
• Inflation
• Guarantee terms
• Fee structures
• We can do this with CAP:Link
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