Fundamental changes in the economic environment have led to a shift in focus of strategic investment policy and risk management. Instead of strictly long-term thinking the emphasis these days is more on a combination of long and short-term perspectives.

 

A long-term investment strategy typically offers some room for deviations in the short term, this in order to adapt to imbalances in the financial markets. Insurers, for example, are able to modify the original investment policy from the long-term strategy through the annual investment plan. After all doing so could accomplish a more beneficial risk-return trade-off of the portfolio. The economic scenarios of Ortec Finance – the Ortec Finance Scenario-set (OFS) – enable institutional investors to not only determine the long-term strategy, but also help to evaluate the risk-return trade-off for various investment categories at a short to medium-term horizon, with the option to (temporary) deviate from the long-term strategy.

The investment decision process

The investment decision process consists of various layers. It is a top-down process ranging from the determination of the long-term strategy in the top layer, usually by performing an ALM study, to the eventual selection of the investments in the bottom layer. Scenario analysis helps institutional investors to make better decisions, particularly in the first two layers. The horizon, frequency, type of decisions and restrictions differ per layer. And in this process every layer determines the restrictions for the layer underneath. The available risk budget and the bandwidths of the Strategic Asset Allocation (SAA) that emerge from an ALM study therefore define the way in which an investment portfolio is constructed.

Determining the SAA is only the beginning of the investment decision process. Specific economic circumstances can make it attractive to temporary deviate from the long-term strategy. Thanks to recent improvements in the dynamic features of the OFS, scenarios can now play an important role in this decision-making as well, for example in the annual investment plan. The risk budget offers room for such deviations. The actual asset allocation can be determined annually through various means of input, such as quantitative analyses based on the risk-return trade-off in the OFS and qualitative considerations. The advantage of the OFS is that the periodical evaluation of the risk budget and potential modifications with regard to the long-term strategy both occur based on the same consistent model. This analysis can moreover serve as a second opinion on proposals by your fiduciary manager or asset manager.


Dynamic scenarios

For what purposes can you use a medium-term investment analysis?

  • As input for the investment plan;
  • As an independent second opinion on the investment advice of an asset manager;
  • As a test whether the investment policy is still optimal considering the current economic conditions.

 

Summarizing the benefits of the OFS:

  • Improve the risk-return profile of the investments based on the current market conditions and accompanying expectations and deviating from the long-term strategy;
  • Justify short-term deviations from the long-term strategy based on an integral and consistent analysis of assets and liabilities;
  • Recommend a certain investment allocation is not merely based on a quantitative analysis, but also on a clear economic justification and qualitative considerations.

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