Moss has warned that the regulator needs to scrutinize the use of stochastic models to ensure they are suitable for the advice scenarios in which they are being used.
Moss blasted mean variance co-variance (MVC) stochastic models as being simplistic and fundamentally unsound for the purposes of forecasting retirement income, warning they are easily manipulated by the assumptions that are made and can lead to significant product bias.
Speaking at the launch of a white paper highlighting concerns over the industry’s readiness for the April 2015 pension freedoms, Moss said Economic Scenario Generators (ESG), which make forward projections as to currency fluctuations and global economic developments, are more suitable for retirement income projections, give a more balanced picture.
Moss said the range of outcomes possible from MVC stochastic modelers can vary hugely depending on the assumptions on which they are based, with projections ranging from an overwhelming likelihood that drawdown will lead to the best outcomes to ones where drawdown is portrayed as worse in all scenarios. He called for providers to publish the assumptions upon which their stochastic modeling tools are based.
He cautioned that investors opting for a cautious investment strategy in drawdown should expect lower returns than they could get from an annuity as without a more aggressive investment strategy their funds would be unable to keep up.
Moss also called on the financial services industry to persevere with trying to make simplified advice work for the retirement market, and to work with behavioural economists to engage and educate consumers.
Moss said: “The FCA needs to put in place a thematic review of stochastic models. MVC models are simply a 3D matrix where you put in assumptions about asset classes, what you think the variances are going to be and how you think that asset class is going to move vis-à-vis other asset classes. The problem is, it is a snapshot in time. MVC models are fundamentally unsound for the purposes of forecasting retirement income and can lead to significant product bias.
“The adviser has no understanding of what is going on inside the black box.”