Scenario analysis is used to construct portfolios which prove successful even with various market developments. A closer look at an intensive two-day workshop.
A narrow, tarmacked country road leads past leafy woods, hilly meadows and a small vineyard to Freudenfels Castle at Eschenz in the Swiss canton of Thurgau. From the parking lot one can look down on nearby Lake Constance. Today, the castle, which was first documented in 1359, serves as the seminar center of LGT Group. It is small, with redstriped window shutters and a baroque, onion-domed tower. The building complex includes a barn and a stable, which have both been completely remodeled, a former ”womens’ house” now containing bedrooms, and a small rose garden with box trees. The air on this early July morning is pleasantly warm, but not yet hot. The occasional tinkling of cowbells adds the final touch to an idyllic scene. Just one hour by road from Zurich, it’s almost as if you have entered an oasis of the past – the perfect place to develop scenarios for the future.
What this entails can be seen later in the castle’s large hall. Around 25 people, attendants of a scenario workshop, are standing in small groups and talking. The CEO of a research boutique in Hong Kong and an analyst from IFC, the investment subsidiary of the World Bank, have just explained the opportunities and risks for emerging markets. During the next two days the workshop participants are to draw up different, but plausible scenarios for these countries: is their dependency on the West diminishing? How could the political emancipation affect their economies? What would happen if the Renminbi fell in value? This technique is known as scenario analysis, a method of thinking in terms of possibilities and picturing various potential future developments.
Almost half of the experts present are from LGT: economists, country analysts and asset managers. The other half consists of external specialists from various disciplines, who bring their expert knowledge to the discussions. These include the long-time Far East correspondent of a leading Swiss daily newspaper and the former head of the think tank of a major automobile corporation. “It’s important that the composition of the working groups is as multi-disciplinary as possible because the economic historian has a different perspective than the sociologist, the energy expert than the urban planner,” says Philipp Becker, one of the moderators of this two-day workshop. The young German studied business administration in St.Gallen and wrote his thesis on scenario analysis in investment strategy. Together with his supervisor, Walter Pfaff, the overall head of asset allocation, he was responsible for building up the scenario analysis function at LGT.
After a free exchange of thoughts and ideas, the work groups disperse to the castle’s various rooms. Their heavy timber beams form a stable setting for the participants‘ brain-storming – now it’s definitely time to think “out of the box”. One of the work groups is discussing the shadow banking system in China, a so-called input factor in scenario analysis. Could this system collapse? What would the consequences be for the economy and the financial markets, but also for China’s society? What exact course would such a collapse take? The group members think through various possibilities, formulate projections, and attempt to systemize their thoughts on a flipchart. Even during dinner in the castle’s former barn the conversation continues to focus on emerging markets, primarily from a business viewpoint but sometimes in the form of anecdotes and travel experiences.
The next morning begins early with mandatory rowing on Lake Constance. The idea is that participants should be mentally fresh and receptive, especially since the next point on the program – which extends over the whole day – is going to be very demanding. All the facts and projections arrived at the previous day must now be consolidated in plausible scenarios. These will be challenged, analyzed and in some cases rejected again. The work groups present their results at the plenum meeting in the late afternoon. The participants, both the internal and external specialists are all visibly impressed with the quality of the knowledge gained.
However, the two-day workshop is only a small section of the scenario analysis process at LGT. During the next few weeks, the scenarios developed for emerging markets will again be carefully examined by the scenario core team at LGT and then integrated in LGT’s already existing overall scenarios. At later workshops, the risk and return expectations of individual asset classes are determined and an optimized portfolio is then formulated for each scenario. Walter Pfaff, the experienced investment strategist, is convinced that this enormous investment in time and effort is worth it: “During periods of rapid, largescale change, it’s almost impossible to correctly anticipate the future. With the use of scenario analysis, however, we can develop a robust, long-term investment strategy, which will prove its value under sharply differing market developments.”
Scenarios describe possible images of the future and show various development paths. Scenario analysis was introduced in the 1970s as a corporate planning instrument and has since found wide-spread use as a means of answering economic and social questions. LGT employs scenario analysis to describe possible developments over the next five to ten years in the global financial markets. Internal and external specialists are brought together to research the fundamental economic, political and social developments and to determine their effects on the financial markets and specific asset classes. The results of their research are incorporated in the drawing up of long-term investment strategy and are then implemented in the portfolios, including those investments made by the Princely Family.
The article was published in the portrait of LGT.
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