The Big IF

STRESS-TESTING BREXIT WITH COMBINED PERFORMANCE

AND RISK ANALYTICS

As every asset manager knows, the whole idea behind risk analysis is to

find out what would happen IF.

As every asset manager knows, the whole idea behind risk analysis is to

find out what would happen IF.

Where performance attribution enables asset managers to measure historic returns...

As every asset manager knows, the whole idea behind risk analysis is to

find out what would happen IF.

Where performance attribution enables asset managers to measure historic returns...

Understanding risk provides a view of the future.

As every asset manager knows, the whole idea behind risk analysis is to

find out what would happen IF.

Where performance attribution enables asset managers to measure historic returns...

Understanding risk provides a view of the future.

This isn’t a clear-cut exercise because...

“There is not one future world. There are a billion possible future worlds.”

DAMIAN HANDZY, GLOBAL HEAD OF RISK, STATPRO

Right now the big IF is a Brexit vote.

This is a major EU referendum. UK residents will vote on June 23rd and their decision will impact markets

around the world, especially currency markets.

IN OUT

Vote LeaveSo, what if the vote is to leave the EU? What then?

IN OUT

For portfolio managers there is a compelling need to evaluate the impact of a Brexit decision in the

EU referendum. UK voters will have a direct impact on their portfolios.

THIS MEANS

Analyzing their impact

on the portfolio.

Being able to identify the right parameters for stress testing.

Pulling in data on those parameters and applying them

to a variety of scenarios.

DOING THIS GIVES SHARPER VISIBILITY

DOING THIS GIVES SHARPER VISIBILITY

Visibility = Action

DOING THIS GIVES SHARPER VISIBILITY

Visibility = ActionIt allows the manager to see when scenarios

become untenable from a risk viewpoint.

As we all know, a Brexit vote would impact all financial portfolios - whether or not they are

directly invested in European or UK securities.

As we all know, a Brexit vote would impact all financial portfolios - whether or not they are

directly invested in European or UK securities.

What would the likely macro impact be?

As we all know, a Brexit vote would impact all financial portfolios - whether or not they are

directly invested in European or UK securities.

What would the likely macro impact be?

What will be the long-term impact of the EU referendum. UK voters are getting ready to have their say.

THREE FACTORS:

Currency markets

UK and EU equities

Commodities

EQUITIES

In the first weeks following a vote to leave the EU, it’s likely that worldwide equities would fall.

UK equities would suffer more than European equities, which would likely suffer more than

other worldwide markets.

CURRENCIES

£

A vote to leave would drag the pound down and could be quite dramatic on the 24th June.

Meantime, money would flow to safe havens such as US bonds and gold. These prices

could increase.

COMMODITIES

Commodities could be expected to take a hit as worldwide

reaction becomes depressed.

What about the specific impact on portfolios?

In this scenario, having a system that enables managers to apply a range of movements to

investments and asset classes is essential.

What about the specific impact on portfolios?

In this scenario, having a system that enables managers to apply a range of movements to

investments and asset classes is essential.

Doing the analytics means identifying at what point a given pressure becomes unbearable.

What about the specific impact on portfolios?

How much stress is too much stress?

This is what we saw...

Suggested levels for stressing various asset classes in the event of Brexit or Remain:

EU REFERENDUM: UK GOES TO THE POLLS

Suggested levels for stressing various asset classes in the event of Brexit or Remain:

EU REFERENDUM: UK GOES TO THE POLLS

Asset class stresses UK remains in the EU UK leaves the EU

Suggested levels for stressing various asset classes in the event of Brexit or Remain:

EU REFERENDUM: UK GOES TO THE POLLS

Sterling

Euro

UK equities

European equities

Worldwide equities

UK bond prices

European bond prices

US bond prices

Gold

Commodities

Asset class stresses UK remains in the EU UK leaves the EU

Suggested levels for stressing various asset classes in the event of Brexit or Remain:

EU REFERENDUM: UK GOES TO THE POLLS

Sterling

Euro

UK equities

European equities

Worldwide equities

UK bond prices

European bond prices

US bond prices

Gold

Commodities

+4% to +7%

+3% to +7%

+5% to +10%

+3% to +7%

+2% to +5%

+1% to +2%

Flat to +1%

Flat to -1%

-2% to -5%

Flat

Asset class stresses UK remains in the EU UK leaves the EU

Suggested levels for stressing various asset classes in the event of Brexit or Remain:

EU REFERENDUM: UK GOES TO THE POLLS

Sterling

Euro

UK equities

European equities

Worldwide equities

UK bond prices

European bond prices

US bond prices

Gold

Commodities

+4% to +7%

+3% to +7%

+5% to +10%

+3% to +7%

+2% to +5%

+1% to +2%

Flat to +1%

Flat to -1%

-2% to -5%

Flat

-5% to -10%

-3% to -7%

-10% to -15%

-6% to -12%

-3% to -10%

-2% to -5%

-1% to -3%

+2% to +5%

+5% to +10%

-5% to - 10%

Asset class stresses UK remains in the EU UK leaves the EU

We added a bit of our own stress

testing to this…

We applied a correlated/predictive stress test on three portfolios:

We applied a correlated/predictive stress test on three portfolios:

A typical global long/short equity

fund.

We applied a correlated/predictive stress test on three portfolios:

A typical global long/short equity

fund.

A US institutional investor portfolio.

We applied a correlated/predictive stress test on three portfolios:

A typical global long/short equity

fund.

A US institutional investor portfolio.

A European asset management

portfolio.

WE RAN TWO STRESS TESTS:

We performed a multivariate regression analysis on the constituents of the three portfolios to

estimate the potential impact on such a portfolio.

WE RAN TWO STRESS TESTS:

We performed a multivariate regression analysis on the constituents of the three portfolios to

estimate the potential impact on such a portfolio.

This is what we saw...

WE RAN TWO STRESS TESTS:

We performed a multivariate regression analysis on the constituents of the three portfolios to

estimate the potential impact on such a portfolio.

This is what we saw...

Global long / short equity

US institutional investor

European asset manager

-3.5%

-0.5%

-3%

-7%

-2%

-5%

Portfolio Brexit small Brexit large

Now we can see what the potential damage

is and where.

SEEING IS BELIEVING

Global long/short equity could drop by as much as 7% in a Brexit large scenario. We might need to make

some adjustments.

7%

US institutional investors are less impacted. Could elements of this strategy be applied elsewhere?

European asset managers could see a 5% drop. Could they

rebalance their portfolio in favor of countries expected to suffer less?

5%

Having the right data to see the initial impact and then delve

deeper means greater insight.

At what point does the pressure become overwhelming?

What are the alternatives?

?

Without being able to perform these analytics,

asset managers are at the mercy of market sentiment.

?

They become passive managers.

• Asset managers need to know the impact of any given event.

• Right now it’s the EU Referendum. UK sentiment is too close to call.

• What would happen to portfolios in the event of a Brexit vote?

• Which elements of a portfolio would gain and which would lose? By how much?

• Having the right technology means asset managers can identify where they need to rebalance the portfolio to mitigate against a ‘leave’ Brexit vote.

• Without being able to see what would happen ‘if’, then managers cannot take action - they become passive managers.

TAKEAWAYS

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