At Dynamic Planner, we have partnered with Citywire, which includes New Model Adviser among its press titles, to produce a series of three, 30min podcasts focusing on cash flow planning and clients in decumulation.

In episode one, Citywire host Ian Horne is joined by Nick Ryan, an adviser with Buckinghamshire firm Yellow Bear Financial Consultancy and by Chris Jones, Proposition Director at Dynamic Planner. In an absorbing debate, they explore the subject of stress testing client portfolios and ask the question, ‘Is it fundamentally flawed?’ Other issues discussed included:

  • What are the practical dangers of stress testing for advisers?
  • What do clients make of it?
  • Should advice firms today decide upon their own growth assumptions, for cash flow planning?
  • How does a stochastic Monte Carlo engine approach the problem?

Below, is a flavour of how the conversation started:

Ian Horne: Is stress testing style over substance?

Nick Ryan: I think it depends on the style and on the substance. If it is ‘old-style’ stress testing, where things are chosen without apparent reason, I would say it definitely is. I’ve seen it done in the past where a 10% fall in a portfolio is modelled in this year or that year with no real rhyme or reason. The intention obviously is good, but there is a danger of simply box ticking.

Ian: How do you avoid doing that and building in scenarios which resemble real-life events?

Nick: This was a big problem until fairly recently. For example, at Yellow Bear, we looked at several different cash flow modelling tools and none of them seemed to cover that. I do my own due diligence, with a friend from another firm and we both looked at this in as mathematical a way as we could and we came to that conclusion. It’s a real weakness in tools and it’s perhaps only a matter of time before the FCA challenges that approach.

Dynamic Planner launched its new cash flow modelling tool in November. I was already familiar with its Monte Carlo, which runs of thousands of simulations and gives you the mean to present to a client. It is more advanced. By factoring in all those projections and all those different connotations, we feel that gives you as an adviser the best average. It factors in financial crises, which we’ve experienced and takes the middle road.

Ian: What has Dynamic Planner done, so stress testing makes more sense and relates more closely to the client’s real experience?

Chris Jones: It’s interesting how words and terms in industries become popularised. ‘Stress testing’ comes from Basel II and really applies to institutions. For example, as the Bank of England does with UK banks. A Monte Carlo like Dynamic Planner’s makes sense, because it transposes into what you’re supposed to do when giving advice – laid out by the FCA in COBS rules – and considering different market conditions, good and bad, when making future projections. From that perspective, that’s what a Monte Carlo simulation captures far better.

Back in the day, when you completed cash flow planning for a client on an Excel spreadsheet, or something similar, and you only had a deterministic return, how would you show bad market conditions? You had to randomly project, ‘What would happen if 2008 happened again? And so forth?’ In that sense, you’re always looking for the next 2008, but it’s never going to be the same thing. Who’d have it would be coronavirus in 2020?

There is a danger then to being arbitrary and picking something which has happened before and the timing of it. From our perspective at Dynamic Planner, once we realised we had the power to deliver such a powerful Monte Carlo forecaster, that is of course what we wanted to do for advice firms. Hopefully, it achieves that.