An asset allocation-based analysis is a common way advisors measure risk in client portfolios. But simplifying risk to the asset class level can create blind spots in decision-making — especially for investors who own individual stocks. In fact, there is often a wide dispersion of risk across different holdings within an asset class that can go unnoticed without reviewing individual security risks.
When only looking at asset allocation, advisors are not able to dissect each holding into its common drivers of performance such as market beta, industry tilts, style factors, interest rates, credit spreads and so on. These risk factors are what really explain the sources of risk in a portfolio. For clients who have concentrated stock positions — often 5%, 10% or more of the total portfolio — highlighting these company-specific risks through a bottoms-up analysis is critically important.
Let’s take Microsoft and Twitter for example. They are both large cap tech companies in the S&P 500. If we performed an analysis using U.S. large cap equities as the asset class — or even technology as a sector — they would be assigned the same level of risk. We know this is not an accurate picture and relying on it could lead to unintended consequences. A bottoms-up analysis of the individual securities provides transparency into the different risks that Microsoft and Twitter actually have.
Same asset class, different risk
Example for illustrative purposes. Source: BlackRock, Aladdin portfolio risk tools. Data as of 9/30/20. See important notes at end for additional information on the S&P 500.
As shown in the chart above, the annualized volatility of the S&P 500 over the past 10 years, which includes Microsoft and Twitter, is 15%. But if you look at the individual securities, you’ll see that Microsoft’s risk is actually 20% and Twitter’s is more than double that at 44%. This means Microsoft and Twitter have the potential to perform very differently within a portfolio — in fact we might expect them to perform differently — yet an asset class analysis alone would tell you they should act the same (15%), effectively ignoring this meaningful difference.
Food for thought
Protein is an important part of our diet. But you don’t ask for “protein” when you want chicken because you could end up with tofu, which changes the entire meal. An asset allocation analysis is like asking for protein — why not just ask for chicken? A bottoms-up analysis offers a more specific and accurate view of risk, which helps prepare the meal clients really want.
Technology makes deeper conversations possible
Wealth management firms and advisors have traditionally used asset allocation because it’s simple, and they haven’t had the means of analyzing risk more deeply at scale across their business. But the technology now exists to make these more meaningful conversations around risk possible. Seventy-five percent of advisors surveyed by BlackRock say that discussions about risk help clients understand their value, suggesting clients want to talk more about risk.*
The charts below show risk and return dispersion for a group of 60/40 portfolios with a bottoms-up view of risk. Over a 3-year period, this risk variation can drive very different return outcomes, which advisors would not be able to highlight with asset allocation-based analyses alone.
Different risks, different return outcomes
Example for illustrative purposes. Source: BlackRock, Aladdin. Data as of 9/30/20.
Advisors who use sophisticated technology to understand the underlying risks in specific portfolios can provide more transparency around potential outcomes and demonstrate more expertise in client engagements to help build trust and deepen relationships.
Aladdin Wealth is that technology…and more
Expectations for how advisors manage portfolios have evolved. When advisors turn on their workstations, the information they need for a deeper analysis is already there with Aladdin Wealth. They can now better understand the drivers of return and risk in their clients’ investments and do more to inform clients of the potential impacts on their portfolios. The portfolio and risk analysis technology available through Aladdin Wealth can help advisors have fewer blind spots when they serve their clients and supports the continued transformation of your wealth business.
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* BlackRock "Tech in Business" advisor survey, 2020. A total of 510 U.S. advisors with at least $25M in AUM participated in the survey.
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