Optimise Your Decisions, Not Investment Portfolios (#fintech)

  • Paolo Sironi, FinTech Thought Leader at IBM Watson Financial Services and author of bestseller "FinTech Innovation" (Wiley 2016)

  • 29.12.2016 09:15 am
  • Optimise decisions

First of all, I would like to thank the many readers that in the last two months since launch of "FinTech Innovation: from Robo-Advisors to Goal Based Investing and Gamification (Wiley, 2016)" have shared their pictures, public comments or sent private emails to discuss the content of this thought leadership work.

"FinTech Innovation" develops on three pillars the concept of personalisation of personal finance:

  • Robo-Advisors: as an example of #FinTech innovation which represents an interesting way forward in the industry for their focus on portfolios (instead of products) and long-term investing (instead of myopic trading). Yet not enough.
  • Goal Based Investing: because the transformation of the Wealth Management industry from a distribution channel of securities into a packaging mechanism of advice requires to move out of traditional testosterone driven marketing (benchmarking, alpha and expected return) and embrace a new cognitive narrative which is based on individual goals and added values.
  • Gamification: because nobody can truly tame the markets, yet learning to invest differently outside conventional habits (do you really think that benchmarking makes sense?) requires to rewire our brains by means of gamified pains and gains, if not profiling our ambitions and risk appetite under gamified stressed market conditions.

Sound financial advice is not only about forecasting expected returns (sorry research guys), but sharing knowledge between advisors and clients on ambitions, risks and uncertainty over time. In between risk management and risk measurement we find a couple of things: take decisions about risk mitigation (such as staying out of equity markets at historical peaks ... tough feelings) which might come at the cost of reduced short-term potential performance (pain today, gain tomorrow), and take decisions about facing uncertainty (ever heard of panic selling?) which can only be imagined beforehand to be handled with reduced anxiety when that day comes (provided we learn - and accept - that uncertainty exists so that we allocate investments to protect our essential goals).

Investment behaviour matters!

Anxiety comes from lack of control, and lack of control from lack of knowledge. Therefore, the heart and soul of FinTech Innovation lays in my previous work "Modern Portfolio Management: from Markowitz to Probabilistic Scenario Optimisation (RiskBooks, 2015)", which discusses exhaustive enumeration techniques to deploy a new engine for portfolio construction and simulation that would allow to extract and deliver with interactive graphical representation the Goal Based Investing insights, on a digital platform, by modeling scenarios over time (hence a space to model uncertainty) and help individuals to make by intuition more informed what-if investment decisions around personal goals. PSO is indeed a piece of operations research, which unbundles a mathematical optimisation into a set of alternative decisions, that is an optimised decision-making framework based on sound and advanced quantitative methods. MATHS and TECH get boiled together!

Truth is that, a 60/40 is always a 60/40 portfolio but the most relevant difference is the knowledge we gain when deciding upon its composition. A portfolio is never optimal because it is mathematically optimal (long live the Queen ... and the efficient frontier!) but because the unbiased operational steps made to create this portfolio allow to simulate uncertain market conditions and gain insight about the way personal events (new job, children's education), market shocks (Brexit, Lehman Brothers' default) and market conditions (negative interest rates, hyper-inflation) can affect performance over time.

This new goal-based narrative, more personalised and supported by digital, is "environmentally cleaner" because it is not based on "retrocessions" nor selling targets, hence it requires a new engine that would not pollute our investments decision-making with overly subjective believes.

MPT is diesel ... PSO is Tesla.

Imagine the hypothetical case (how wonderful, though, it would be) that Angela Merkel would call Volkswagen imposing that by 2020 only electric cars could be sold in Germany. Big data, though extremely relevant and powerful, can certainly help to devise who, among existing costumers, should be the target of marketing campaigns. Yet, the first thing Volkswagen should solve is the creation of an efficient electric engine to comply with the new regulation and customers' demand for enhanced driving experience and performance. Same with banks today and regulation (MiFID2, RDR, PRIIPS, DOL Fiduciary Standards ... you name it).

In essence, that is a piece of what, with humble passion and visionary foolishness, my latest works attempt to share and explain:

How to innovate in FINance, to make best usage of innovation in TECHnology!

In this inspirational journey through social media shares and travels around the world, I am so pleased to have learned and still learn from all of you working in banks, funds, consulting, Fintech and diverse industries.

Time for change is yesterday, let's make change now.

by Paolo Sironi, Spokesperson for IBM Investment and Risk Analytics, FinTech Thought leader and Author of books in quantitative finance and FinTech innovation.


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