Tapping a Wealth of Data to Improve Portfolio Risk Management

Morgan Stanley Wealth Management has become one of the largest firms in the industry by serving a broad client base. “Our clients range from small, self-directed investors, who interact with us through our E*TRADE  channel, to ultra-high-net-worth individuals and family offices who rely on our financial advisers for advice,” says managing director Chris Scott-Hansen. “We are a leader in  institutional consulting through Graystone, and we have a workplace business that serves stock plans and their participants.”

Every day, Morgan Stanley financial advisers are on the front lines providing the full range  of services, including investment advice and planning, banking, and lending. In the background, a risk organization provides governance. “They sit at the top and review down, to make sure policies, procedures, regulations, and laws are being adhered to,” Scott-Hansen says. “Together with our financial advisers, they work to serve the best interests of our clients.”

In the past, risk officers estimated risk by proxying securities to their respective asset classes and analyzing those classes’ historical returns. “They had platforms and tools to measure risk in a lot of different ways,” Scott-Hansen says. “But, like most of the industry, they used historical risk data to support decision-making. We wanted to better understand risk now—every day, on every investment decision that’s made—and how each decision changes the risk in client portfolios dynamically.” Additionally, the firm’s legacy process gave financial advisers limited transparency to information around risk supervision and variances, so they were not always able to fully explain their risk projections to clients.

Morgan Stanley began scouring the industry for a solution that could help its risk officers and financial advisers see clients’ investment risk in new ways. None of the options the project team found could fully meet their needs. “A lot of the tools were very focused on stock and bond portfolios,” Scott-Hansen says. “But since the ’80s and ’90s, client portfolios have evolved. Many now include annuities, structured products and alternative investments, ETFs [exchange-traded funds], mutual funds, and SMAs [separately managed accounts]. We didn’t see a toolset that could understand all those products uniquely while also bringing them together to calculate exposures across individual accounts, groups of accounts, or lines of business.

“We had the idea to build out a unique platform that did not yet exist in the industry, a platform that could understand wealth management clients’ portfolios and business from a number of different perspectives,” he continues. “We wanted to understand where our risk allocation was and how decisions made over time would impact returns on the clients’ portfolios. We needed a solution that would automatically consume and analyze information, then show users insights that were highly actionable. It also needed to be scalable, with no limits in terms of number of clients or products. It needed to be relatable—whether a client has $1,000 with us or $100 billion with us, the insights coming out of the tool should meet their needs. And then, it needed to be able to evolve constantly. I’m a true believer that perfection doesn’t exist, but that we can always make progress in pursuit of perfection.”

The firm partnered with BlackRock to jointly develop a custom tool on top of the Aladdin risk analytics engine that consolidates information and analyses on all the asset classes Morgan Stanley Wealth Management offers. Incorporating Morgan Stanley products, in particular, required a great deal of collaboration.

“For example, structured products aren’t public investments, so there’s not a lot of data readily available, and at the time BlackRock didn’t have the analytics for them,” says Nick Biedermann, a vice president in the Investment Solutions group at Morgan Stanley. “We worked closely with the desk that distributes these here at Morgan Stanley and with BlackRock’s modeling teams to take BlackRock’s understanding of risk factors and analytics and plug in Morgan Stanley’s data and product knowledge to create differentiated analytics.

“We took a similar approach on the alternative side,” Biedermann adds. “Everything from REITs [real estate investment trusts] to energy infrastructure assets to hedge funds and private investment funds, which have historically been less transparent in terms of publicly available data. Pulling all these assets into the model is a good example of how Morgan Stanley and BlackRock leaned on our respective strengths to build a differentiated and unique platform.”

The tool they built, which they call the Portfolio Risk Platform, leverages a model that incorporates more than 3,000 risk factors to project current risk and the exposures inherent within hypothetical scenarios. It offers the results, in real time, via views tailored to risk officers, financial advisers, and clients.

To take full advantage of these capabilities, the Morgan Stanley team revamped the firm’s supervisory controls and monitoring processes. The volatility variance supervision process is designed to confirm that the risk within a client portfolio is appropriate based on the client’s answers to Know Your Customer (KYC) questions and its risk profile.

“Every day, and even intraday, we measure whether the client portfolio’s risk is suitable for them,” Scott-Hansen says. Morgan Stanley risk officers use new volatility metrics in those determinations, which help the firm ensure that forward-looking risk analytics are leveraged for key decisions. “When risk officers see blips on the radar, they can dive deep quickly and identify risk that may be outside the range of suitability. Then they can work with our financial advisers to get clients back where they should be in achieving their specific financial goals.”

Meanwhile, the platform’s risk allocation process helps financial advisers better understand exposures in client portfolios by breaking down the factors that contribute to risk. The Portfolio Risk Platform delineates risk across factor groups, such as country, sector, style, rates, and spread risk.

“Suppose we have a client who’s managing their portfolio on their own, using Morgan Stanley in a brokerage-oriented relationship, and they’re taking more risk than what they’ve told us they’re comfortable with,” Scott-Hansen says. “The Portfolio Risk Platform enables our financial adviser to see this and engage the client, highlight the areas of risk, and show them what could happen if markets were to move in one direction or the other. The client may turn out to be comfortable with the potential downside, but our advisers can engage them in that conversation.”

The tool also provides book-level views that enable financial advisers to easily scan their book based on a variety of risk metrics, performance metrics, and scenario analyses. Robust filtering capabilities enable them to sort through their books as needed.

“We can also roll it up to the full-firm perspective,” Scott-Hansen says. “We can look at: If the S&P dropped 10 percent right now, what would happen to the firm, where would it happen, and what securities would drive that movement? We can also look at risk events of the past—say, Covid-19, the Great Recession, the Lehman Brothers crisis—and see the factors that moved the most at that time. Then we can shock our current holdings to simulate what would happen if that event occurred again today.

“This is very important from an overall firm risk management perspective,” he continues. “It’s helpful in our conversations with regulators, the Fed, and ratings agencies, all of which have shown interest in how we can handle risk given our millions of clients and the hundreds of thousands of investment products that our clients can access.”

The 2024 Alexander Hamilton Awards program is open for submissions through September 1, 2023. Learn more here, and enter today!

See also:

• Gold Award—Microsoft: “Leveraging the Blockchain to Improve the Supply Chain”
• Bronze Award—Paychex: “Reducing Risk and Creating Value for the Company”

Having everyone looking at the same information is a key benefit of the Portfolio Risk Platform. “In building out the tool, we thought it would be unfair to give certain information and analyses to our governance team and not give similar lenses to the people interfacing with the clients,” Scott-Hansen explains. “So we built a toolset that our financial advisers can use to analyze their account base and target areas of opportunity to engage clients around risk advice.”

Getting there required a major lift for the project team, but the results have been well worth the effort. Not only does Morgan Stanley Wealth Management now have better, and more rapid, insights into risk at all levels, but the tool has supported revenue growth. Through 2023, top users of the Portfolio Risk Platform have had faster-growing portfolios and have been managing more assets and accounts than advisers who engage less with the platform.

Nevertheless, the team is not resting on their laurels. “All of us have a very interesting trait of attention deficit advantage,” Scott-Hansen says. “We are constantly rethinking, and engaging clients, prospects, advisers, risk officers, and sales partners for ideas to improve the tool.” This attitude of continuous improvement helps Morgan Stanley support clients through periods of market volatility.

“When Russia invaded Ukraine, we wanted to make sure our clients, advisers, and risk organization knew where we had exposure to Ukrainian- and Russian-centric securities,” Scott-Hansen says. “We used the Portfolio Risk Platform to give them stress tests, analytics, and information so they could make better decisions. When we put that out there, we got tremendous feedback; everyone appreciated that we were able to quickly evolve and respond to the market environment, both putting risk information in the hands of our advisers and understanding where we, as a firm, had different types of exposures.”

More recently, the team used the tool to provide risk information around the problems at regional U.S. banks and Credit Suisse. “We showed people where they had both equity and credit exposures to troubled assets,” Scott-Hansen says. “Some clients exited certain types of investments; others decided to hold. But we empowered them with information to decide which action to take. As markets zig and zag, we can now present information quickly so people can make the right decisions.”

In fact, he concludes, that is his key takeaway from this project: “Never assume you know everything; always keep your eyes open for opportunities to know more,” he advises. “The individuals managing risk at Morgan Stanley are brilliant, in my view, but the world can change in the blink of an eye, and they need to evolve with it. Access to information, so that they have their arms around the risk, is crucial. And they have to be willing to stretch their arms further to reach around anything that may pop up. The only way we have a collective future is to think and then rethink and then think again.”