Advisers must reconsider risk in client portfolios as markets enter what will be a "low return decade" for fixed income investments, according to an industry expert.
The risk discussion has previously focused on examining past results and it's concentrated on equity risks. Neither of these approaches alone are going to work going forward, said Mark Peterson, director of investment strategy for BlackRock, speaking at the Financial Planning Association's national conference in Orlando on Sunday.
"Quantifying risk is one of the industry's greatest challenges," he said.
The industry needs to diversify by risk source across portfolio investments, said Mr. Peterson, whose firm has $13 trillion under advisement in its risk management group. Just like diversification is a strategy used to account for equity risks, portfolios will need to include many types of bond investments, too.
"Embrace bond diversification," he said. "Your safe stability asset class is going to be challenged over the next decade."
Advisers will need to help clients understand the role that risk plays within their portfolios and consider the impact that changes in factors such as inflation, interest rates, currencies, political situations and liquidity risk will have on the portfolio as a whole, he said.
But it's difficult to capture the effect of different sources of risk, Mr. Peterson said.
To that end, BlackRock is making available to financial advisers who work with BlackRock or its iShares exchange-traded-funds a portfolio stress testing tool. It analyzes the risk within portfolios of about 45 different scenarios, such as a spike in oil or gold prices or large change in inflation, Mr. Peterson said.
He calls the approach, "the Moneyball of risk," referring to the 2011 sports drama in which managers assemble a competitive baseball team using a technical analysis approach. Down the road, he believes, everyone will take such considerations into account when evaluating portfolio risk.
"Even though the last 50 years have been all about equity risk, it's not going to be going forward," Mr. Peterson said.