Citywire printed articles sponsored by:
View the article online at http://citywire.co.uk/wealth-manager/article/a709419
How are wealth managers stress-testing for a US default?
by Elsa Buchanan on Oct 16, 2013 at 07:42
As the budget stalemate rumbles on ahead of Thursday's deadline, raising the spectre of a potential US default unless the debt ceiling is raised, how are wealth managers stress-testing their portfolios against the unthinkable happening?
To put it into perspective, the US has $12 trillion in outstanding debt, which dwarfs the $517 billion Lehman Brothers owed when it filed for bankruptcy five years ago this week and this was sufficient to drive the S&P 500 down by almost half.
Determining historical data to facilitate stress-testing is the biggest problem, says Kevin Gardiner, managing director and head of investment strategy at Barclays Wealth. The US has only ever technically been in default, for example in 1979 when it made a late payment which it blamed on a processing error and included additional interest for, and in 1790 when it deferred interest payments.
This means plotting such a scenario in the current globalised world is nigh on impossible, albeit it is clear the impact would be colossal.
‘The nearest thing you could think of is when the US’s creditworthiness was downgraded in 2011, which saw US Treasuries perform very strongly. But that is only a halfway precedent,’ adds Gardiner (pictured).
For other managers, stress-tests could be based on other extreme historic events.
Gary Reynolds, director and chief investment officer at Courtiers, frequently stress-tests portfolios against a number of such scenarios.
‘We stress-test specifically for four downside risks including the 1973 oil crisis, Black Monday in 1987, the tech bubble bursting in 2000, 2008’s Lehman’s crisis, and a positive event such as the market recovery in the summer of 2009,’ he explains.
This time, Reynolds says, Courtiers is using the stochastic Monte Carlo method, which uses non-predictable or random variables, with, for example, 25% volatility compared to a more normal 15% on the S&P in a less secure environment.
‘This will help determine how bad things could be if the US defaulted on the bottom end, and what we should hedge,’ he said, adding he would consider buying puts on the S&P 500 to take some downside risk out, and back gold.
News sponsored by: