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How Would Your Clients' Portfolios Hold Up in a Dreaded Black Swan Event?

Britain’s surprise vote last month in favor of leaving the European Union caught markets off guard, leading to $2 trillion in losses for investors around the world. The market volatility may have clients asking about other, less obvious risks in their portfolios, and the likelihood of similar events in the future. A new tool from Morningstar may help.

The research firm launched its Global Risk Model Tuesday, aimed at helping investors identify sources of return, and risk, in a stock or portfolio of stocks. Risk is measured using 36 different factors across style, sector, region and currency characteristics. 

“The factor exposures in our model root out underlying revenue drivers to find a stock’s true sources of returns,” the firm said. “Our model uses the exposures to go beyond standard models to project a stock or stock portfolio’s vulnerability to extreme market events.”

There are a total of 11 style factors, some of which are proprietary, such as Morningstar’s Economic Moat Rating and Fair Value estimate. Other style factors include liquidity, momentum and financial health. There are 11 sector factors, including energy, financial services and technology. There are seven region factors, including developed Americas, developed Europe and emerging Middle East. The model also uses seven currency factors, including the Euro, British Pound, Swiss Franc and Canadian dollar. One example: Morningstar can find how an increase in the Euro/U.S. dollar exchange rate would likely drive the value of a particular stock.

The tool analyzes more than 40,000 stocks and 10,000 equity fund portfolios in Morningstar’s database to come up with a forecast of future returns based on the factor exposures.

For example, Morningstar’s Economic Moat Rating measures a company’s competitive advantage — a higher advantage should better protect investors during extreme market events.

The new risk model can also calculate value at risk and the probability of negative returns, among other variables, Morningstar says. “This gives you an idea of what’s at stake if a ‘black swan’ event hits the market,” the researcher said.

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