Why traditional stress tests fail in today’s markets

Over the past decade, regulatory changes have fueled the growth of private markets, driving some portfolios into uncharted territory. Traditional risk models, premised on the transparency of public markets, are not sufficient to estimate the volatility of a portfolio that includes both public and private investments.

Volatility metrics typically extended through scenario modeling and forward-looking analytics must now be refined to capture the uncertainty associated with the convergence of public and private markets. This is essential for a comprehensive risk assessment as advisors and their clients to navigate the complexities of blended portfolios.

New risk realities

Volatility still matters today, but it’s only part of the story. As more portfolios include private and semiprivate investments, other types of risk are coming into focus that aren’t easy to measure with traditional tools.

Liquidity, for instance, is a big one. Products like interval funds are seeing a resurgence based on the perception that they offer flexible access. However, a closer look will often show restrictions that limit investor access. Advisors need to understand not just what a product promises, but how it actually behaves when liquidity is tight.

Valuation is another growing challenge. In public markets, you can usually count on consistent pricing data. But, when it comes to private assets, pricing updates can be infrequent, methodologies vary, and data points can be patchy.

Private capital funds also report performance differently, often using internal rate of return instead of standard return metrics. This makes it difficult to compare private assets to public market investments, hindering unified risk analysis across portfolio segments. Disclosure standards differ from one private vehicle to the next, making it tough to draw clear comparisons.

Morningstar is developing tools to bring more clarity to the picture, incorporating factors such as redemption structures, gating histories, and liquidity event patterns.

Standard stress tests fall short

Traditional stress tests assume things like continuous pricing and readily available historical data that aren’t always available when dealing with alternatives.

In practice, asset managers and advisors are left piecing together risk profiles from a patchwork of sources – PDFs, manager commentaries, sparse fact sheets. This fragmentation makes it challenging to gain insights or spot emerging risks early.

We make the invisible visible

Morningstar is addressing persistent data gaps in private markets by advancing proxy-based modelling and scenario tools. When traditional data isn’t available, proxies often become the next best option. Public filings, manager commentary, and index-based stand-ins can offer valuable clues, shedding light on parts of the market that would otherwise remain opaque.

We’re enhancing analysis of alternative exposures in hybrid vehicles by evaluating fund strategy and intent – not just holdings-based exposure – especially in cases where transparency is limited.

Morningstar is also developing an asset allocation framework to bring alternative exposures into sharper focus. We’re expanding coverage across vehicles and asset classes from private equity and venture capital to private credit and semiliquid funds, providing advisors access to 1,000 private capital funds’ information in Direct Advisory Suite.

Plus, our new “percent private” data point reveals the level of private market exposure. Our Risk Model has been expanded to give a more consistent view of portfolio risk regardless of vehicle structure or market type. The Morningstar Portfolio Risk Score will now include breakdowns of a portfolio’s “% Risk from Volatility” and “% Risk from Liquidity”.

Real understanding is the first step

While many accredited investors meet the wealth or income thresholds, that doesn’t always mean they fully understand the intricacies of what they’re investing in – especially when it comes to private markets.

In complex portfolios, misalignment between expectation and reality can lead to surprises no one wants. This is where advisors play a critical role, and the right tools can make this part easier.

Frameworks that break down things like liquidity structures or risk exposure into plain, actionable insights can support better discussions and stronger client relationships. It's about creating alignment between what clients think they’re getting and what their portfolio actually delivers.

When that happens, risk goes down, confidence goes up, and portfolios become stronger for it.

Resilient portfolios over reactive

Advisors and asset managers need to shift their portfolio construction strategies from reactive to resilient.

That means going beyond traditional volatility measures to:

• Conduct rigorous liquidity assessments
• Push for clearer, more consistent disclosures
• Distinguish between perceived and actual risks
• Benchmark thoughtfully across relevant peer groups

Nowadays, we’re working with familiar tools in new contexts, where access may be limited and disclosures less consistent. This is a shift away from the transparency and daily liquidity of earlier investment vehicles. Resilience here means not just reacting to shocks, but preparing for them with better tools, deeper data, and stronger client alignment.

Gain more insight into modern risk and how to adapt through Morningstar.