Let’s start with what Is Stress Testing?
Fixed Income Portfolio Stress Testing is a computer simulation technique used to test the resilience of investment portfolios against possible future interest rate movement at a certain point in time. Such testing is customarily used by the financial industry to help gauge interest rate risk and the adequacy of assets, as well as to help evaluate internal processes and controls. In recent years, regulators have also required financial institutions to carry out stress tests to ensure their capital holdings and other assets are adequate.
Traditionally, stress testing has utilized historical methodology of testing a portfolio. However, a stress test may not always account for unexpected risk dynamics. It is important to also keep in mind the 2 largest risks to a fixed income portfolio are Credit and Market Risks.
Fixed Income portfolio managers need to understand how portfolios are affected by extreme interest rate movements, interest rate volatility and yield curve inversion potentiality and this test can greatly help in this regard.
Stress Testing for Risk Management
Companies that manage assets and investments commonly use stress testing to determine portfolio risk, then set in place any hedging strategies necessary to mitigate against possible losses. Specifically, a portfolio manager may use internal proprietary stress-testing programs to evaluate how well the assets they manage might weather certain market occurrences and external events.
Complacency and surplus/portfolio management should never be connected. Unfortunately, we are seeing quite a bit of complacency in the investing public. If having a stress tested portfolio sounds like a good idea, we would have that conversation with you.