Such nuance creates complexity when it comes to analyzing portfolios and risk. Financial professionals may use proxies because these complicated instruments are hard to model properly. But this common modelling method may be too general to capture enough detail that understands the inherent risks, especially if there are many different types of investments working together inside a portfolio.
What could be a more effective way?
Building to see risk clearly
Proxies are an important tool but can only provide approximations. In some scenarios, they may not account for all the hidden risks within certain types of structured products.
This creates a challenge for advisors, who could miss the nature of what they’re trying to accomplish for their clients during the portfolio construction process, and in client conversations.
What’s enough detail for a decision?
Suppose you are browsing for a new home. A description on the number of bathrooms alone likely isn’t enough information to make a thoughtful decision –or to understand all the elements that may make a place right for your specific needs.
A proxy might not be either for structured products in a portfolio.
Beyond the window
There’s only so much a generic proxy can do. Advisors who can incorporate greater detail into their analyses can better serve their clients’ critical needs for deeper clarity.
One way that advisors can improve their experience is by getting more specific with a bottoms-up, full revaluation for scenario analysis that uses the full terms and conditions of each security, instead of risk parameters to proxy assuming normal distribution.
Modelling structured products based on daily terms and conditions enables advisors to see the potential impact of risk factors before they happen. Advisors can then boost risk/reward conversations with a more complete view of the payoff scenario than just a window of it.
Spotting the details
Let’s dig a bit deeper by looking at a scenario with a sample structured product.
We’ve selected an autocallable structured note that has coupon memory. It’s a complex structured product with many different drivers of risk.
In the chart below, we stress tested how the note would perform when European stocks go up, or down by 10%.
See how there are two very different analyses based on whether you used a proxy or full revaluation model.
How might these analyses shift client conversations?
For illustrative purposes only. 3 Year Tenor, Mono on Euro Stoxx, Quarterly Knockout at 100%, European Knockin at 70%, Quarterly Coupon at 8%, Memory Conditional Coupon at 80%.
As European markets fall (left), the structured product nears breaching its downside barrier. The full revaluation framework captures the increasing equity exposure while using a proxy significantly underestimates the resulting negative return.
When European markets are rising (right), falling volatility in the up-shock generates positive return in the proxy. But when using a full revaluation, the increased likelihood of knockout is captured, outweighing positive returns.
The proxy didn’t capture the full risk picture because of the inherent non-linearity of the structured product. It showed an equal gain or loss of 1.51%, in up or down markets. It didn’t effectively model the specific terms and features of the asset.
With the full revaluation comparison, advisors don’t have to rely solely on proxies.
Advisors can improve client conversations and build portfolios that are better tuned with risks that proxies might miss.
Constructing portfolios with Aladdin Wealth™
The Aladdin Wealth™ platform’s risk engine captures data on a broad array of structured products in the universe. Our teams model these products to keep up with mark-to-market sensitivities.
Our tools help advisors see more clearly into any asset type and how each asset impacts a full investment portfolio. With an enhanced risk picture, advisors can save valuable time to build relationships with clients and discuss financial goals.
© 2022 BlackRock, Inc. All rights reserved.
This material is provided for informational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are subject to change at any time without notice. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Performance and risk calculations, including those incorporated into Aladdin Wealth technology, are based on assumptions, historical correlations, and other factors (such as inputs provided by the Aladdin Wealth users) and are not assured to predict future results. All graphs and screenshots are for illustrative purposes only. BlackRock’s Aladdin Wealth platform is a financial technology platform designed for institutional, wholesale, qualified, and professional investor/client use only and is not intended for end investor use. Aladdin Wealth users undertake sole responsibility and liability for investment or other decisions related to the technology’s calculations and for compliance with applicable laws and regulations. The technology should not be viewed or construed by any Aladdin Wealth users, or their customers or clients, as providing investment advice or investment recommendations to any parties. This material should not be construed as a representation or guarantee that use of Aladdin Wealth technology will satisfy your legal or regulatory obligations. BlackRock, as provider of the technology, does not assume any responsibility or liability for your compliance with applicable regulations or laws. For additional information on any of the descriptions contained herein, please contact your Aladdin Wealth Relationship Management representative. BlackRock may modify or discontinue any functionality or service component described herein at any time without prior advance notice to you.
In the U.S. and Canada, this material is intended for public distribution. In the UK, this material is for professional clients (as defined by the Financial Conduct Authority or MiFID Rules) and qualified investors only and should not be relied upon by any other persons. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock. In the EEA, this material is for professional clients, professional investors, qualified clients and qualified investors. For qualified investors in Switzerland: This information is marketing material. This material shall be exclusively made available to, and directed at, qualified investors as defined in Article 10 (3) of the CISA of 23 June 2006, as amended, at the exclusion of qualified investors with an opting-out pursuant to Art. 5 (1) of the Swiss Federal Act on Financial Services ("FinSA"). For information on art. 8 / 9 Financial Services Act (FinSA) and on your client segmentation under art. 4 FinSA, please see the following website: www.blackrock.com/finsa. In Singapore, this advertisement or publication is intended for public distribution and has not been reviewed by the Monetary Authority of Singapore. In Hong Kong, this material is intended for public distribution. The technology and the material have not been reviewed by the Securities and Futures Commission of Hong Kong. In Japan, this is for Professional Investors only (Professional Investor is defined in Financial Instruments and Exchange Act). In Australia, issued by BlackRock Investment Management (Australia) Limited ABN 13 006 165 975 AFSL 230 523 (BIMAL). The material provides general information only and does not take into account your individual objectives, financial situation, needs or circumstances. In Brunei, Indonesia, Philippines and Malaysia, this material is issued for Institutional Investors only. In Latin America, for institutional investors and financial intermediaries only (not for public distribution). No securities regulator within Latin America has confirmed the accuracy of any information contained herein. Please note that IN MEXICO, the provision of investment management and investment advisory services (“Investment Services”) is a regulated activity, subject to strict rules, and performed under the supervision of the Mexican National Banking and Securities Commission (Comisión Nacional Bancaria y de Valores, the “CNBV”). BlackRock does not provide, and it shall not be deemed that it provides through Aladdin Wealth technology, any personalized investment advice to the recipient of this document, by reason of its use or otherwise. These materials are shared for information purposes only, do not constitute investment advice, and are being shared in the understanding that the addressee is an Institutional or Qualified investor as defined under Mexican Securities (Ley del Mercado de Valores). Each potential investor shall make its own investment decision based on their own analysis of the available information. Please note that by receiving these materials, it shall be construed as a representation by the receiver that it is an Institutional or Qualified investor as defined under Mexican law. BlackRock México Operadora, S.A. de C.V., Sociedad Operadora de Fondos de Inversión (“BlackRock México Operadora”) is a Mexican subsidiary of BlackRock, Inc., authorized by the CNBV as a Mutual Fund Manager (Operadora de Fondos), and as such, authorized to manage Mexican mutual funds, ETFs and provide Investment Services. For more information on the Investment Services offered by BlackRock Mexico, please review our Investment Services Guide available in www.blackrock.com/mx.
©2022 BlackRock, Inc. All rights reserved. BLACKROCK and ALADDIN WEALTH are trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owner.