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Portfolio Consulting as a Process: Simulation-Based Client Orientation

© Joachim Löning

Scenarios play an important role in investment advice. They establish the context from which an investment decision is made. Only the embedding in a scenario makes the decision to buy a certain product plausible and motivates it. That is why we show in this article what role scenarios play in thinking, what added value is achieved with the consistent digitalisation of scenarios and which product categories are suitable for implementing scenarios in the portfolio.

People think in scenarios

Humans are virtually addicted to classifying the information that constantly flows at us. For this purpose, our brain has a processing procedure that runs quickly and efficiently and mostly automatically. The comparison of sensory impressions with suitable memory contents automatically leads to plausibilisation in the sense of taking things for true. One can imagine existing memory contents as drawers. If several memory contents are linked with each other in the imagination and their consequences are carried forward, we speak of scenarios. We encounter scenarios as basically imaginable and thus probable versions of the future.

What does that have to do with investing money?

In anthropological terms, the ability to decide quickly and automatically whether there is a threat to life and limb is of great importance. An investment portfolio may not pose an existential threat. However, considerable losses can be threatened if we misjudge the development of the markets. Checking the plausibility of assumptions about the framework conditions of one’s own portfolio is an essential part of dealing with the investments one has and holds.

Plausibility check of a purchase decision

Plausible stories have always played a major role in investment advice. Fund issuers, for example, regularly write strategy papers in which markets are examined and development possibilities are reflected. The product manufacturer is implicitly saying: This is how we think about investing. If this sounds convincing to you, it is because it is in line with your own idea of the world and the way things work, and that is why my product is right for you.

Comfortable investing

A fund is the product of the convenient implementation of a plausible investment scenario. Do it yourself investors can get into the plausible investment story and advisors can use the scenario that suits the client in each case to put him at the centre of the investment decision. This works very well in the market and has led to an almost unmanageable number of scenarios and products today.

Holistic investing

When the decision for the investment and thus for a scenario is pending, it is obvious to ask what effects the scenario that has been qualified as plausible would have on the investments already contained in the portfolio. Let us first take a look at the framework conditions for such a holistic approach:

  • Compliance
    Legally, the seller of a product is not obliged to assess the effects on (old) portfolios associated with the purchase of a product and even if the same seller or advisor sold an investment in my portfolio at an earlier point in time, there is no post-contractual obligation to provide advice for the product already sold.
  • Software
    There are no tools with which the effect of scenarios on a portfolio can be calculated and presented. Nevertheless, the possibilities are manifold. For example, the portfolios of a customer base can be identified that would be particularly affected by a certain scenario.
  • Product range
    In the case of probable losses or gains, specific investment opportunities arise, each of which results in a different access to the bank’s offer shelf. If there are no suitable products for scenario-specific portfolio advice, this represents valuable information for the bank’s offer planning and product constructors.
  • Customer loyalty
    By taking up scenarios, the advisor can dive into the processing and decision-making mechanisms that the client uses anyway. The client can be shown the scenarios that are significant for his portfolio or the advisor can allow the client to try out the effects of different scenarios. This strengthens the bond with the client.

Products matching scenarios

Most investors and advisors know that every investment involves uncertainty. The same is true for investment scenarios, which give context and direction to an investment decision. Advisors who can consider the effect of likely scenarios on existing investments are able to find investment products with suitable characteristics.

Funds can be chosen to enter a suitable, actively managed market segment for a scenario that has not yet been invested in. If an investor is already invested in a scenario with one or more securities, he can hedge a scenario by choosing certificates that have the desired effect for his existing portfolio when a scenario occurs.

The calculation of the effect of scenarios on existing individual portfolios is still in its infancy. In this article, some functional aspects and possible use cases were highlighted. With a scenario tool, we can immerse ourselves in the thinking and decision-making mechanisms of clients and generate real-life added value. Advisors equipped with this tool consolidate customer loyalty and the erosion of fees is countered with service and advisory quality in personalised product sales.

We have the essential parts of this value chain for initial use cases in place at tetralog and we look forward to opportunities for demonstration and further development.

Lothar Jonitz, 25.01.2021

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