Rethinking Risk: How Stress Testing Must Evolve for Today’s Market Realities

Over the past decade, regulatory changes have fueled the growth of private markets, driving some portfolios into uncharted territory. Traditional risk models, which are premised on the transparency of public markets, are not sufficient to estimate the volatility of a portfolio that includes both public and private investments. And while volatility metrics are typically extended through scenario modeling and forward-looking analytics, these tools also must be reviewed and refined to capture the uncertainty associated with the convergence of public and private markets. This is essential for a comprehensive risk assessment, enabling advisors and their clients to navigate the complexities of blended public and private market portfolios.

When we talk about risk in today’s market, it’s no longer just about how prices move. Volatility still matters, but it’s only part of the story. As more portfolios include private and semi-private investments, other types of risk are moving into the spotlight—and they’re not always easy to measure with traditional tools.

Liquidity is a big one. Products like interval funds are seeing a resurgence due to their structure. They appear to offer flexible access, promising things like quarterly redemptions. But dig into the fine print, and you’ll often discover restrictions that limit investor access. These details can catch clients off guard, especially in times of market stress. That’s why advisors need to understand not just what the 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 private assets don’t follow the same playbook. Pricing updates can be infrequent, methodologies vary, and data points can be patchy. Advisors often have to rely on custom reports or point-in-time performance snapshots—making it much harder to forecast with confidence.

Compounding this is the difference in how private capital funds report performance, often using internal rate of return (IRR) instead of standard return metrics. This can make it difficult to compare private assets to public market investments and hinders unified risk analysis across portfolio segments.

Then there’s transparency—or sometimes, the lack of it. Disclosure standards differ from one private vehicle to the next, which makes it tough to line up investments side-by-side and draw clear comparisons. Advisors often find themselves stitching together incomplete or inconsistent information, which adds another layer of complexity to building a clear risk profile.

To help address some of these challenges, Morningstar has been developing tools that aim to bring more clarity to the picture. By incorporating factors such as redemption structures, gating histories, and liquidity event patterns, emerging tools and frameworks aim to create a more structured and meaningful way to compare and evaluate liquidity risks across hybrid portfolios.

Traditional stress tests just weren’t built for private markets. They assume things like continuous pricing and readily available historical data; conditions that often don’t exist when you’re dealing with alternatives. These models tend to look in the rearview mirror—but for many private investments, the data isn’t there to support that kind of backward-looking analysis.

In practice, asset managers and advisors are left piecing together risk profiles from a patchwork of sources—PDFs, manager commentaries, sparse fact sheets. The information is often inconsistent, hard to parse, and sometimes incomplete. Such fragmentation makes it tough to surface meaningful insights or spot emerging risks early.

One way the industry is making progress is by improving how these investments are classified. For instance, leveraging a taxonomy like the one developed by PitchBook can help bring order to the chaos by grouping funds into more consistent, comparable categories. While this doesn’t replace the need for detailed holdings data, it does offer a stronger starting point—giving advisors a clearer view of what they’re working with and enabling more relevant peer comparisons.

Morningstar is helping address persistent data gaps in private markets by advancing proxy-based modeling and scenario tools. These efforts aim to simulate risk where direct data is missing, especially for less transparent or newer vehicles. 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—helping to shed light on parts of the market that would otherwise remain opaque.

Used thoughtfully, proxies can be powerful tools. Inputs such as redemption terms, liquidity windows, and gating histories are often fed directly into proxy-based models to simulate how funds might behave under stress. These elements help paint a more complete picture, especially when direct performance data is limited or unavailable.

Proxy-based models are also useful when you're evaluating funds with little to no historical track record. For example, if a new interval fund lacks its own history, a proxy might use a composite of similar funds or index data to estimate performance and risk. If they're clearly labeled and transparently disclosed, proxies can provide structure where there would otherwise be a data void—supporting more informed decision-making in areas like valuation and risk management.

Morningstar is enhancing its 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. This initiative offers advisors clearer insight into where alternative risks lie within client portfolios. Tools like these are part of a broader push to help advisors match portfolio composition with liquidity preferences and risk appetite.

Morningstar is also developing a top-down asset allocation framework designed to bring alternative exposures into sharper focus—even within traditional investment wrappers like mutual funds and exchange-traded funds (ETFs). Rather than solely relying on granular holdings data, this new view helps advisors identify where alternative strategies are embedded in client portfolios, supporting clearer communication and more deliberate portfolio construction.

We’re expanding coverage across vehicles and asset classes from private equity and venture capital to private credit and semi-liquid funds, providing advisors access to 1,000 private capital funds’ information in Direct Advisory Suite.

In addition, our new “percent private” data point reveals the level of private market exposure.

Morningstar is also expanding its Risk Model to include private capital funds and introducing new portfolio risk and liquidity metrics that deliver a 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”—chief concerns around private investments.

Data is only as useful as our ability to explain it. And 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.

That disconnect can create its own kind of risk. When clients assume they understand something—or worse, when we assume they do—misalignment can creep in. And in complex portfolios, that gap between expectation and reality can lead to surprises no one wants.

This is where advisors play a critical role. Beyond portfolio management, you’re also translators—taking technical, often abstract risk metrics and turning them into conversations that make sense to clients. It’s about helping people feel informed, not overwhelmed.

The good news is that the right tools can make this easier. Frameworks that organize complexity—breaking down things like liquidity structures or risk exposure into plain, actionable insights—can support better discussions and stronger relationships.

Ultimately, 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. These advancements are designed to benefit both sides of the advisory relationship. For financial advisors, better tools mean more confident guidance. For accredited investors, especially those new to private vehicles, these frameworks provide clarity—reducing risk and strengthening decision-making.

For advisors and asset managers, this evolution represents a shift from reactive to resilient, enabling more informed decision-making in the face of uncertainty, and representing a new philosophy for how to calculate risk in finance.

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

Building better risk analytics isn’t just a tech challenge, it’s a collaborative one. The quality and depth of insights Morningstar can offer depend heavily on the willingness of asset managers to share normalized, high-quality data. As more firms participate, that collective input forms a powerful quorum: one that allows advanced metrics, proxy models, and scenario-based stress testing to reflect real-world dynamics more accurately. In this way, asset managers play a pivotal role in shaping the next generation of risk tools—not just for their own portfolios, but for the broader financial ecosystem.

Advisors and asset managers are navigating familiar tools repurposed for new contexts, where access may be limited and disclosures less consistent. This shift marks a departure from the full transparency and daily liquidity that characterized earlier investment vehicles, demanding more deliberate oversight. Resilience in this context means not just reacting to shocks, but preparing for them with better tools, deeper data, and stronger client alignment. That’s how advisors and asset managers can continue to build portfolios ready for whatever comes next.