The Essential Role of Advanced Market Risk Tools with Look-Through Capabilities in Wealth Management

The Changing Landscape of Portfolio Management

Wealth management is undergoing a transformation.

Many advisors are shifting from focusing on individual stock selection to creating customized portfolios using ETFs and model portfolios.

ETFs, which offer granular exposures across asset classes, have become a preferred tool for building portfolios tailored to clients' unique financial needs.

This trend reflects a broader shift where financial planning and holistic client needs are taking precedence over traditional investment management.

With fee compression impacting the wealth management space, advisors must differentiate themselves by addressing clients' comprehensive financial goals.

Model portfolios, while growing in adoption, require sophistication to integrate effectively.

Advisors well-versed in portfolio construction often use a mix of model portfolios and ETFs to address specific client needs.

The result?

Multi-asset portfolios that include ETFs, mutual funds, private assets, fixed income, and even derivatives.

The Challenge of Multi-Asset Portfolios

Managing risk in such complex, multi-asset portfolios is no small feat.

Traditional risk measures like standard deviation or ex-post metrics such as Sharpe and Treynor ratios fail to capture the nuances of these portfolios.

They overlook the underlying exposures and the intricate interplay between asset classes.

The true challenge lies in understanding the risks embedded within the underlying holdings of ETFs, mutual funds, and private assets.

Without this, risk analysis remains superficial, masking potential vulnerabilities and overexposures.

The Case for Ex-Ante and Look-Through Risk Analysis

Forward-looking risk analysis, or ex-ante analysis, provides a more dynamic approach.

This includes capabilities like:

• Scenario Analysis: Assess portfolio impacts under historical and hypothetical market conditions.
• Stress Testing: Model extreme market shocks and their effects on portfolio risk/exposure.
• Value at Risk (VaR): Quantify potential losses under different confidence levels.
• Liquidity Analysis: Understand the time and cost to liquidate positions, down to the underlying assets.
• What-If Analysis: Test portfolio position adjustments in real-time to evaluate changes in risk and exposure.

However, even advanced tools like these fall short without a deeper understanding of the portfolio’s inner workings.

Enter look-through analysis, a method to analyze the portfolio using the underlying holdings within funds.

Look-through analysis, long popular in the institutional space due to the complexity of their holdings, I think it is now gradually gaining traction in wealth management.

This shift may be attributed to increasing awareness or a move beyond the traditionally simpler asset classes in wealth management that previously did not necessitate such detailed analysis.

Another factor potentially driving its growing adoption could be the limited transparency about the underlying portfolio(s) and the reasoning behind constructing a portfolio of portfolios.

One approach to look-through analysis is to break down all underlying portfolios into their fundamental components—equity, fixed income, or cash—and analyzes them against key risk factors affecting those asset classes like interest rates, FX rates, asset prices, etc.

Unlocking Insights Through Look-Through Analysis

Look-through analysis transforms opaque fund structures into transparent, actionable data.

By dissecting underlying holdings, firms can:

• Conduct dynamic exposure analysis to uncover sector, geography, and asset class concentrations.
• Aggregate exposures across portfolios to detect over-concentration and unintended risks.
• Simulate stress scenarios and historical events to model potential drawdowns.
• Evaluate liquidity under various conditions, identifying time-to-liquidate and price impact metrics.
• Perform advanced risk analysis, including Conditional VaR and shock scenarios for specific risk factors.

Key Challenges in Advanced Risk Analysis

Despite its benefits, implementing advanced market risk tools comes with challenges:

1. Data Procurement: ETFs provide daily holdings data, but mutual funds and private assets often lag in transparency.
2. Proxy Securities for Illiquid Assets: Illiquid securities may require proxy modeling, a time-intensive process.
3. Incomplete Pricing Data: Missing price details necessitate manual effort to maintain data accuracy.
4. Real-Time Integration: Combining risk analytics, performance, and attribution data into a real-time, centralized platform demands robust technology.

The Technology Solution: Real-Time Insights

Modern technology makes it possible to overcome these hurdles. Advanced risk tools, powered by cloud-native architectures and API integrations, enable real-time data ingestion and analytics.

A centralized data warehouse or data lake stores this information, allowing business intelligence tools to deliver deep portfolio insights.

Firms leveraging such tools gain the "holy grail" of wealth management: a whole-of-fund view that empowers better decision-making and enhances client outcomes.

Why Now?

The rise of multi-asset portfolios, coupled with fee pressures and increasing client demands, necessitates a shift to advanced risk tools.

Wealth management firms must position themselves as leaders by adopting technologies that provide transparency, scalability, and actionable insights.

This is no longer optional.

Clients expect customized solutions and sophisticated risk management to navigate today's complex financial landscape.

Firms equipped with advanced market risk tools are better prepared to meet these demands, stay competitive, and build lasting client relationships.

TL;DR

The future of wealth management lies in addressing the challenges of multi-asset portfolios with forward-looking tools and look-through analysis.

Advanced market risk tools not only provide transparency and agility but also empower firms to deliver on their promise of tailored, high-quality client service.

As the industry evolves, the ability to harness these tools will distinguish the leaders from the laggards, shaping the next era of wealth management.