Enhancing Portfolio Risk Assessment Using Scenario Analysis

In this post, our research team shows how returns-based scenario analysis can be used to enhance traditional portfolio risk analysis by helping to assess potential fund performance through extreme market events.

September 13, 2018

This is the third in a series of posts in which our research team leverages new investment risk analytics in Stylus Pro to demonstrate how historical and forward-looking stress tests can provide deeper insight into fund performance across various market regimes and hypothetical scenarios.

Scenario analysis goes beyond traditional risk measures (i.e., standard deviation, VaR, max drawdown, etc.) by enabling you to pose the question, “what might happen to my fund or portfolio if…?” To fill in the blank and answer almost any query you have, you simply shock the fund or portfolio with the appropriate market index, rate, credit spread or economic factor. (Factor selection and thorough testing is an important step in this process; we explore this issue in a previous post: How to Ensure Your Portfolio Risk Analytics Are Working as Expected.)

In this post, we analyze a group of 338 target-date funds (TDFs),1 which offer a particularly good illustration of the value scenario analysis provides. TDFs, which are popular defined contribution investment offerings, have risk characteristics that are intended to become more conservative over time as the fund gets closer to its target retirement date. A large loss due to an extreme event could be disastrous to prospective retirees as was seen for some near-dated funds in 2008, the worst of which lost more than the S&P 500 index. (If you’d like to read more of our research on target-date funds, you can find it here.)

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