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Financial Risk Management

Financial Risk Management

This network brings together professionals involved in the oversight and management of their company's financial risks and exposures as well as solution vendors, in order to discuss risk issues including interest rate risk, foreign exchange risk and commodity price risk, among others.

How FinTech Impacts Portfolio Risk Management

17 November 2017  |  2646 views  |  0

The Internet. Nothing has disrupted our lives more.

And one of the biggest more recent disruptions has been in the financial industry. While alternative banking first began with PayPal, the development of financial technology (fintech) has been steady, albeit gradual, ever since.

Then, the financial crisis of 2008 hit and consumers lost trust in the big banks and investment firms, choosing instead to find their own solutions with alternative methods of banking and investments.

The need for consumers to be more in control of their own financial services, along with their growing faith in technology, created the “perfect storm” for fintech, especially the use of big data to turn investing into far more of a science than an art. And that “science” has transformed the methodologies of portfolio risk management.

How FinTech Changes Portfolio Risk Management

Risk management isn’t only about avoiding risks in investments.

It is about understanding risks and making decisions based upon the risk tolerance of investors and the potential for profits associated with risk tolerance. And it is analyzing the potential for various types of risks.

Portfolio risk managers face two types of risks:  

  • Systemic risks are those that cannot be controlled – natural catastrophes, wars, etc.

  • Non-systemic risks which are the result of human activity – such as decisions made by companies that impact their growth and profits or lack thereof.

They deal primarily with non-systemic risks, and they generally use two strategies in doing this:

  1. Asset Class Allocation – what proportions of a portfolio are in the stock market¸ bonds, cash, precious metals, real estate, etc.

  2. Diversification. Within each asset class, managers tend to divide investments into a variety of sectors – oil, tech, and other business and industrial sectors. The idea is that some will do well while others may not, but, overall, wealth management will stay on track to provide growth to investors.

Traditionally, these management strategies have been accomplished manually.

Portfolio managers did deep research into potential investments, analyzed daily, weekly, monthly, and annual trends, and advised their clients based on these analyses.

Enter Fintech and Portfolio Risk Analysis Software

Such software gathers big data, categorizes it, churns it, analyzes it, and, in conjunction with AI, spits out reports that give portfolio managers solid information based upon factual data, not just “gut” feelings or incomplete human research. And because individual investors now have access to all of this data, many believe that they can manage their own portfolio risk rather than rely on professional investment advisors.

Whether individuals strike out on their own or continue to use investment advisors, the impact of risk analysis software means that managing portfolios has been transformed.

  • In 2000, there were two robo-advisor online firms. Today, there are 52 online investment advisory firms. Also, it is predicted that robo-advisement globally will reach $8.1 trillion in investment dollars by 2020.

  • Add to the robo-advisor craze, the use of AI tools by fintech, patterned after “Einstein” predictive analytics tool and IBM’s Watson. Such tools, incorporated into investment risk management, will be able to calculate and predict risk with much greater accuracy.

  • Fintech software solutions for risk management are cheaper than traditional manual research, and they are faster. Speed and efficiency is what younger investors demand.

Robo-advisors and AI tools can be used by individuals or professional investment advisors, but one thing is certain: investors want digital investment solutions, and fintech is providing just that.

In fact, according to a McKinsey report in June, 2015, between 40 – 45% of “affluent” investors ($25,000 or more to invest), who changed investment firms in a two-year period of the study, did so because they wanted firms that were utilizing solutions offered by fintech.

And the same study reported that 72% of under-40 investors stated they would have no problem managing their own portfolios with virtual financial advisors.

Moreover, a 2017 survey conducted by Tiburon CEO Summit XXXI reported that millennials would take investment advice from Facebook, Google or Amazon, if big data and AI were utilized in making those recommendations.

So What Are the Functions of Portfolio Risk Management Software?

Charles Schwab began as a discount brokerage in the 70’s. And when fintech entered the scene with software products that incorporated robo-advisors and AI, the company’s sustainability was threatened.

Ultimately, it developed its own software product, Schwab Intelligent Portfolio. In terms of portfolio risk management software features, the following were present:

  • The tool will identify the associated risks of asset classes, sectors, etc., based on specific queries.

  • It can predict risk based on simulated scenarios, such as those associated with natural disasters.

  • It can provide portfolio analytics that shows comparisons of holdings based upon analysis of historical trends.

  • It can generate portfolio modeling and give predictive analysis of risks and rewards.

  • It can provide recommendations based on individual or company tolerance for risk and long-term ROI’s.

Schwab developed customized fintech software to serve its enterprise needs. And what it has demonstrated is that financial risk management software can put science into investments, if designed correctly.

By using these trading risk management tools, individual investors and portfolio managers can make decisions and recommendations that are based on solid data, and the potential for meeting investment goals and achieving satisfaction is much greater.

Why Fintech Innovation in Risk Management Cannot Be Ignored

Investors have become far savvier. They know that there are tools out there that give them the same information that investment advisors and portfolio managers can access.

Some of these tools provide investment automation which they can set up on their mobile devices. As Elena Mesropyan, Global Head of Content at Let’s Talk Payments, recently wrote:

“Another major product differentiation…is auto-rebalancing of the portfolio…with robo-advising, auto re-balancing is taking care of that potential loss”.

Today’s young investors are believers in technology and understand what big data can offer. And if they continue to use the services of portfolio managers, they demand that those managers use the latest in digital solutions.

What today’s young investor wants is as follows:

  • He wants a financial advisor with solid information about risks and potential profits. If that advisor is on top of fintech solutions software and using it to analyze trends and make predictions, it is likely that the investor will remain loyal.

  • He wants access to his portfolio manager. And managers can be accessible far more often if risk management software is doing a lot of the “heavy lifting”.

  • He wants total transparency with regard to risk, and providing the results of risk management software analyses to the client will develop trust.

Fintech startups are the fastest growing entrepreneurial sectors and are commanding billions in investment capital. And what they offer consumers and portfolio managers are investment alternatives – alternatives that allow them to use the science of big data, robo-advising, and AI to have more power and control in managing investment risk.

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