Fintech readies factor-based risk model for advisers

Fintech startup Fabric is bringing new risk management tools into the hands of financial advisers.

Fabric is gearing up to offer MSCI Inc.'s factor-based risk model, which extends to analyze exposure to ESG, most notably climate change, to Main Street advisers and investors, according to the announcement. The fintech readies its offering at a time when debates around risk methodologies are heating up among competing fintechs, and investors are leaving their advisers because they didn’t understand their risk tolerance.

Fabric aims to differentiate itself from other risk management tools by hinging its product on factor-based risk models versus most off-the-shelf risk management platforms that rely on historical asset class correlations, which are "intrinsically backward looking and have been prone to break down in recent years," said Fabric co-founder and CEO Govinda Quish.

“The notion of looking at the past to understand risk is an incomplete view and probably a misleading view,” Quish said in an interview. “What every investment adviser has to publish on their material is that past performance is not indicative of future returns, but why do certain companies think that when it comes to risk that's not true?”

Factor-based risk models look at a number of characteristics that are associated with either higher returns or lower risk, such as momentum, value or size. Other factors have to do with sector exposures, like technology, fossil fuels or geography. For advisers, the appeal of factor analysis is the ability it provides to make investment decisions based on those factors, which are regarded as a more precise tool for portfolio construction and risk management.

In the past, advisers have been underserved when it comes to this type of risk management tool that has been available to Wall Street only, said Fabric co-founder and chief risk officer Rick Bookstaber, who has held chief risk officer roles at Morgan Stanley, Salomon, Bridgewater and the University of California Regents Pension Fund and served at the Treasury in the aftermath of the 2008 financial crisis.

“Standard risk models that have been used historically, for the last 20-plus years, have been built by broker-dealers who care about managing the risk on their blotter until they can get rid of their positions over the next two or three days,” Bookstaber said. “Then they're used by hedge funds that care about what's going to happen at their next reporting period, which is a month down the road and all they care about is returns.”

In fact, it makes more sense for advisers to have access to these institutional-grade tools since advisers are on the front line dealing with individual investors who are the ultimate asset owners, Bookstaber said. What Fabric’s tool hopes to accomplish is having advisers and investors understand risk as a narrative with unfolding twists and turns in the plot versus a static shock that just happens.

"Risk doesn't doesn't have to be 2008," he said. "It's about anytime that there's something looming that people are concerned about — inflation being a case in point right now."

Fabric has opened up a waitlist for advisers to sign up for the new risk management tool that is slated to go live in the fall, according to the announcement.