In This Article
- Risk Modeling
- Toggling Advanced Risk Modeling
- Changing Market Assumptions at the Portfolio Level
In every Riskalyze portfolio, we calculate a Six Month Value At Risk (VaR).
For example, our Risk Number® and corresponding six-month 95% Historical Range™ is a historical calculation using a variety of statistical inputs, based on the price history (expense ratios, dividends, etc.) at the holding level. This last statement bears repeating; we do not use the antique process of mapping holdings to a set of assumptions at an asset allocation level. Price, at the holding level, is truth. We derive our statistics from each holding's actual price history because it's more robust than an asset allocation mapping methodology.
Even though our six-month 95% VaR is a historical calculation that does not explicitly say "here's what is predicted to happen in the next six months," we assume that humans may implicitly apply historical probabilities into the future.
While we can all recite the phrase "Past Performance Is No Guarantee of Future Results" for a reason, we test our methodologies to inform best practices for those who implicitly use the past as an input for what to expect in the future.
The underlying market assumptions for calculating the Six Month Historical Range is an important factor in this equation. Our technology is model-agnostic, but we needed to develop a solid and stable one that advisors could reliably use with clients.
The results speak for themselves — for the $2 billion in portfolios built on this data model in 2012, we were far above 95%. Less than 1.6% of portfolios broke below projected risk, despite the serious volatility in May 2012, or the high number of AAPL-heavy portfolios that dropped in value in the fall of 2012.
All investments are calculated using the actual past performance of their returns, standard deviation, and correlations.
Regardless of which return mode is used, Riskalyze uses volatility and correlation statistics to calculate the width of the Six Month Historical Range and corresponding Risk Number.
The standard deviation and correlation matrix give Riskalyze the statistics needed to calculate the distance between the downside and upside returns in the 6-month range. With these modes and advanced tools, advisors can control whether the mean of the 6-month range is calculated based on market assumptions (“outlook”) or strictly historical average returns.
Specific to standard deviation, when securities newer than 1/1/2008 are presented, Riskalyze assists advisors in making apples-to-apples comparisons between younger and older securities by use of Extrapolation. Thus, Extrapolation mitigates a younger fund appearing out of harm's way when it's stacked next to a seasoned, veteran investment.
There are two Risk Modeling options:
- Average Return — Each portfolio will use an average return calculation for each security. For an in-depth analysis, see our Average Return Methodology guide. This is the default model.
- Advanced Risk Modeling (ARM) — Calculates the six-month range based on historical data in conjunction with capital market assumptions. When enabled, each security is filtered into one of four return modes and modeled accordingly. For an in-depth analysis, on how we calculate the four return modes, see our Advanced Risk Modeling guide.
IMPORTANT NOTE: It's important to think about Risk Modeling in terms of Advanced Risk Modeling (ARM) being toggled ON or OFF.
When ARM is toggled ON, each investment is funneled into one of four return modes.
When ARM is toggled OFF(default), each investment is modeled using Average Return.
Toggling Advanced Risk Modeling
To enable ARM, navigate to MENU -> Settings -> Account Details-> Risk Model and toggle it on:
After toggling ARM on, you can select a default Market Assumption by clicking the SET DEFAULT MARKET ASSUMPTIONS dropdown:
After choosing a new default, you will need to specify whether it should be applied to ALL of your portfolios (including all existing client portfolios and model portfolios), or only to new portfolios that you create:
Disabling Advanced Risk Modeling
To disable ARM, navigate to MENU -> Settings -> Account Details -> Risk Model and use the toggle switch to turn it off.
Note: Upon disabling ARM, all existing portfolios will be set to the Average Return risk model. Also, any new portfolios you create will use the Average Return model by default.
Changing Market Assumptions at the Portfolio Level
When ARM is enabled, you can selectively override your default Market Assumptions by choosing a different Market Assumption on the portfolio page. After opening the portfolio, click the MARKET ASSUMPTIONS dropdown (in the upper left) to select a different model:
The portfolio's Six Month Historical Range and Risk Number will now update to reflect the newly selected Market Assumptions.
PRO TIP: For a deeper dive into the calculations behind each investment's Risk / Return Scenario, check out our Riskalyze Academy lesson, Diving Deeper: Understanding the Worst Case / Best Case Figures. For more information (including a quick video if that's your style!) on the Historical range, check out our lesson on Analyzing a Current Portfolio Historical Range.