Target market documentation and future scenario testing

From an end-client perspective, communications related to the make-up and performance of investments and markets (both backward and forward looking) can add huge value. High quality communications help individuals to maintain confidence during times of stress and provides important context in making key decisions alongside their adviser – including, for example, aspects such as the imAs part of PROD, most MPS providers or advised model users have a clear definition of ‘Target Markets’ for their investment portfolios. This will outline aspects such as the types of investors for which a model portfolio is suitable, alongside their risk appetite, time horizon and so on. There is nothing new here and most MPS providers or in-house investment managers will provide these to advisers recommending the investment solution(s) an ongoing basis.

Whilst shared target market definitions are a relatively well trodden path, in our opinion evidenced portfolio scenario testing is far patchier – but just as important. In addition to the target market assessment, the Duty puts a greater emphasis on portfolio stress and scenario testing. In particular, the Duty is clear in asking the MPS provider and adviser to evidence how they have done their bit to ‘avoid foreseeable harm’.

We would expect advisers to see, for example, analysis showing how MPS portfolios have been tested across multiple future different economic scenarios, as well as how the investment process checks, on an ongoing basis, that portfolios remain appropriate given the specific risk target being sought. This is likely to require in-house quantitative analytical capability – often referred to as ‘stochastic optimisation and forecasting’ - on the part of the investment manager. Relying on ‘a gut feel’ from an experienced individual or investment committee is unlikely to cut the mustard!

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