Jabre Capital Partners is a multi-family office and independent wealth management company founded by Philippe Jabre, who continues to preside over the company as CIO and CEO today. This article will look at stress-testing asset portfolios and why liquidity planning matters.
As the 12-year bull market stalls, savvy investors are increasingly turning their attention to risk modelling and management. Asset managers need to have confidence that their recommendation will hold up in volatile markets. In addition to assessing how large a return they stand to gain, investors also need an adequate grasp of what could happen in the worst-case scenario.
Stress-testing an asset portfolio prepares investors for unforeseen circumstances, putting minds at ease. It involves modelling hypothetical market conditions to enable investment analysts to better understand how the portfolio might react to pressure. Stress-testing applies historical data to current market conditions, enabling investors to make data-driven decisions regarding risk management.
Portfolio stress-testing enables investors to gauge portfolio risk factors, improving their understanding of risk exposure at an aggregate level and helping them to identify which holdings contribute to that risk most. It involves assessing the maximum drawing, looking at past market scenarios to provide a better steer in setting a realistic baseline for future market ups and downs. Although past performance is no guarantee of future returns, historical data can provide context to an investor’s assessment of risk and reward.
Comparing a fund to an index benchmark such as the S&P 500 enables investors to better understand the quality of its performance, helping them to discern whether it might be worthwhile to assume more risk for potentially greater returns.
There are two types of scenario that analysts use to forecast potential portfolio outcomes: market-driven and macro-financial. Market-driven scenarios calculate the potential impact of market events, zeroing in on how changes to a particular index or security could impact the investment or portfolio overall. By adjusting the percentile of the distribution, the length of the scenario’s duration and the type of market shock, analysts can pressure-test portfolios in a range of possible scenarios, predicting how the fund’s projected performance would look, the possible worst-case outcome for the fund and how likely is it to achieve the projected outcome.
Macro-financial scenarios, on the other hand, calculate the impact of user-specified macro-financial and economic system shocks, asking questions such as: ‘If the 2007 to 2009 mortgage crisis were to repeat itself, how would the investor’s portfolio stand up?’ Macro-financial scenarios help investors to appreciate the drivers of market risk in historical scenarios, with this knowledge informing their decision-making, enabling them to better identify how their portfolio would perform in a severe or protracted bear market and how they are capturing the upside of sector booms or regional economic tailwinds.
Stress-testing can reveal information gaps as well as risks masked by substandard data. It is a fundamental component to inform strategic portfolio management decisions that protect and enhance the value of asset portfolios. Key risk factors to model in private market portfolios include the portfolio company’s runway and performance, valuation compressions and contraction, and follow-on financing and reserve capital risk. Data-driven portfolio stress-testing provides investors with a deeper understanding of their asset portfolio, enabling them to identify vulnerabilities and make better-informed decisions.
When investing in private markets, accurately gauging risk is paramount. Traditional risk models often fall short when it comes to dealing with opaque data, illiquidity and long-term investment time horizons. Stress-testing is a critical aspect of effective portfolio management, paving the way for the identification of vulnerabilities, optimised risk-return profiles and improved investment choices.
