The client situation
Under the Corporations Act, providers of financial products are required to include Standard Risk Measures (SRMs) within Product Disclosure Statements (PDSs) for each investment option offered. The purpose of these SRMs is to simplify the concept of investment risk by providing investors with a single metric to assist in comparing investment options.
While SRMs are a regulatory requirement and are reasonably simple to interpret, they do not effectively reflect the range of investment risks that clients face. Based on these challenges, the client engaged Rice Warner to assist in the design and calculation of a series of Customised Risk Measures (CRMs) that would be presented alongside the required SRMs to provide additional context on the risks associated with various investment options.
In developing a suite of suitable CRMs, we facilitated a discovery session with key stakeholders to better understand the portfolio drivers and the risks that needed to be communicated. Through this session we identified that portfolio growth relative to macroeconomic indicators and the mitigation of extreme losses were key factors of interest. From this it was decided that a measure based on the probability of exceeding various return thresholds would be most useful and readily understood by the client’s end users.
We leveraged Rice Warner’s stochastic investment model to simulate the characteristics of each investment option. This model, which is based on Rice Warner’s annual survey of expected asset class performance, draws on decades of investment modelling to help us form a forward-looking view of the potential investment returns and anticipated volatility of various asset classes. The model was used to simulate the client’s portfolio, from which we analysed and quantified the probable range of potential outcomes to which investors may be exposed.
Following the analytical phase, the calculation results were collated into a report with commentary to summarise the key features of the results. In providing this report, we facilitated a second meeting to step through the results and the basis for our calculations. This ensured that the results were in line with expectations and could be reconciled with the client’s intention for each portfolio.
Outcome for the client
After receiving our CRM calculations, the client disclosed the provided figures in their PDS documentation. This allowed the client to meet their regulatory requirements and to improve the client experience. Feedback received from the client’s end users following the issuance of these CRMs indicated that the additional disclosure provided a clearer picture of the nature of each investment option and the clients for whom the products were suited.
Beyond meeting compliance requirements, discussion of the provided analysis gave the client greater clarity on the relationship between changes to product settings and the information disclosed in PDS documentation. While not a key input to portfolio decisions, this provided important context on the implications of future changes to the portfolio’s construction.