By Lee Sherman
There was a time when the two main ways to determine investment risk lived happily side-by-side and many advisors even used both. Not anymore.
On May 11, sabers were drawn when Riskalyze launched a marketing campaign claiming the risk methodologies used by its competitors, including HiddenLevers (which oddly still lists a partnership with Riskalyze on its website), and RiXtrema were “wildly inaccurate” and nothing other than “predictive guesswork”.
In contrast, Riskalyze claims that its Historical Data Model is both more accurate and more fiscally responsible. Is it right?
In reality, both of the apps from Riskalyze and HiddenLevers that investment advsiors rely on are more alike than different. They both use predictive modeling technology to perform risk analysis and portfolio stress testing. But the one from Riskalyze, proving out the adage that the best predictor of future performance is past performance, is based on what it calls a Historical Data Model.
A Historical Data Model relies upon what the company refers to as objective data to calculate a range of historical probabilities for a portfolio, based on the actual risk in the underlying securities. It intentionally avoids any subjective assumptions that can lead to guesswork. It uses market data feeds exclusively to paint what it considers to be a more stable and accurate picture of markets over the long term.
A Predictive Data Model considers the odds of a variety of future economic events (or levers) to build a model of how those events can impact your portfolio. These events include such things as inflation, currency fluctuations, interest rates, oil prices, commodity prices, the impact of news events, etc. It attempts to model how each lever affects each individual asset. Advisors then rebalance a portfolio as necessary in an attempt to guide it to the desired outcomes. While decisions based on these levers are, by their very nature, subjective, it’s important to remember that they are being made by experts with a track record of performance.
While Riskalyze calls HiddenLevers risk model, “guesswork”, many advisors swear by its accuracy which it detailed in a white paper in 2020. HiddenLevers’ model projected direction and magnitude of impact in 95% of cases studied across scenarios from Oct 1987 through March 2020. When COVID-19 caused a market disruption, the model projected performance within 5% of actual results for 15 of 16 securities across travel, hospitality, energy, tech, and other sectors.
What’s more, HiddenLevers claims that other models don’t capture the nuance of economic events (the impact of oil prices, airline travel, or other indicators) on the market.
Riskyalyze remains the market leader by a wide margin so it’s clear that advisors, regulators, compliance teams, and other C-level executives in enterprise value its methodology. Both approaches have their fans.
At the end of the day, each company uses data to create a model of market performance based on different sources or inputs and algorithms. The difference is that one looks backwards at actual past performance, while the other attempts to predict future performance based on an analysis of how economic events typically impact the market. And both of them are able to achieve an impressive level of performance.
Today’s investor is lucky to be living at a time when such powerful technology is at her disposal.
Lee Sherman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Lee is an experienced journalist and editor with over 30 years of expertise with a significant history of writing in the personal finance and technology arenas.