Faq Categories: Test Simulation

Adaptive seeks to smooth out the ride—and level the playing field—so investors can stay invested for long-term growth with tools which are otherwise the province of the ultra high-net-worth.Request an Adaptive demo or pilot account to test drive our breakthrough fintech technology. Pilot users can securely link brokerage accounts for automated risk analysis and downside protection pricing.

Downside protection, often called a portfolio hedge, is a general term for investments and other agreements which pay off in market and portfolio declines. Common forms include ‘put options’ and futures contracts which require special expertise and trading permissions.

Downside protection can limit potential losses, thus reducing the overall risk of a portfolio even while staying invested for potential growth.

The cost of downside protection is a drag on a portfolio’s performance, compared to an unprotected portfolio. At the same time downside protection can sometimes lead to improved risk-adjusted returns as compared to buy-and-hold without protection, if protection proceeds are reinvested at lower prices in a portfolio which is growing over the long term.

Adaptive’s Forward Test tool is not investment advice. These kinds of simulations can be used to model the potential range of outcomes for different investment strategies or asset allocations. By comparing the distributions of potential returns, volatility, and downside risk for different scenarios, investors can make more informed decisions about which strategies to pursue and how to manage portfolios.Request an Adaptive demo or pilot account to test drive our breakthrough fintech technology. Pilot users can securely link brokerage accounts for automated risk analysis and downside protection pricing.

Monte Carlo simulations such as Adaptive’s Forward Test tool are only as good as their assumptions about the probability of what is being simulated.

If these assumptions are incorrect or poorly calibrated, the simulation results may be inaccurate or misleading. To address this, it is important to use realistic and well-calibrated inputs, and to perform sensitivity analysis to test the robustness of the results to different assumptions.

Please contact us for more technical information. Forecasting tools tend to assume long-term growth in stocks, in keeping with long-term trends. Adaptive’s Forward Test, however, does not currently assume growth—instead it assumes a market on the whole that goes nowhere even though this likely underestimates the gains in long-term portfolios. Some of other Adaptive’s inputs include: historical returns for correlation estimates; implied volatility for calculating forward returns; and historical volatility, in part as a sanity check for implied volatility calculations.

A key feature of Adaptive’s Forward Test is the ability to simulate the possible effects of downside protection, and to compare outcomes to a portfolio without downside protection. The interaction of Simulation Length, Protection Period, and Protection Level can affect these results.

• Protection Renewals.If the Simulation Length is longer than Protection Period, say five years of Simulation Length and one year of Protection Period, then the simulation assumes renewals of the downside protection at the same Protection Level and Protection Period. This assumption can greatly affect simulation results in part because the Protection Level is expressed as a percentage, so renewals for a rising portfolio will have higher dollar levels of protection, and likewise renewals for a falling portfolio will have lower dollar levels of protection.

There are a few nuances: (1) any Protection Payouts are added to the market value of the portfolio, in effect simulating reinvestment at the lower prices and, in an overall rising market, using Protection Payouts to ‘buy the dips’ as a potentially potent form of countering negative compounding; (2) whether there are Protection Payouts or not, the Forward Test finances Protection renewals out of the market value of the portfolio, meaning that there is some rebalancing to maintain portfolio allocations; (3) the Forward Test uses the current implied market volatility as its assumption for the cost of any renewals during the simulations, but in the real world the cost of renewals will be affected by the market conditions which might price protection higher or lower than current levels.

Forward Test games out possible investment returns in the future, based on the risk of your portfolio and its components, by charting many possible paths and the likelihood of various outcomes.

The largest gains and losses tend to be the least likely, akin to the low probability for instance of repeated coin tosses which are almost all heads or almost all tails.

Forward Test also help you compare the effects of downside protection for a portfolio in limiting potential losses.

Forward Test is a form of Monte Carlo simulation, which can be helpful for making more informed decisions and managing risk, by considering a wide range of potential outcomes. Read more about the use of Monte Carlo simulation in finance at Investopedia and Wikipedia.