Recently I attended Thesis Asset Management’s annual adviser conference: In Pursuit of Excellence: Helping Advisers Build Better Businesses.
Over the coming weeks I will share insight from each of the presentations I sat in on. This week I will commence the series with a review of the session presented by Rory Percivall, ex-FCA Technical Specialist, titled Risk Profiling: pitfalls and solutions.
The team at DISCUS know Rory quite well, and he presented at our very first event on discretionary due diligence. In his presentation, and the discussion that followed, he highlighted the risks associated with mapping a client’s attitude to risk with a suitable portfolio (read a summary of the points he raised here).
We understand that this is a key focus area for Rory and during his presentation at the Thesis conference he shared some of his preliminary findings from the research report he will release later this year.
Below you will find a summary of the seven key issues Rory identified that advisers should be mindful of when risk profiling clients.
1. Results don’t always match the client’s answers
When assessing a client’s attitude to risk, in certain cases, the output of the risk profiling tool might not align to the client’s answers to the questions. Where this happens, it is recommended that the adviser explains why the inconsistency has occurred and make a record of their clarification to the client.
2. Contradictory client answers
Advisers may find that the client’s answers to the risk profiling questionnaire are contradictory. For example, the client might answer some questions suggesting they have a low risk tolerance and others that indicate a higher risk appetite. To make sure an accurate risk profile can be applied, Rory recommends that advisers clarify what the client means by their responses and record it.
Rory stressed the importance of clarification:
“Clarification is key, and without it the client’s attitude to risk will not be clear”.
Furthermore, as an adviser, if you haven’t clarified contradictory responses then you will not have demonstrated the suitability of your portfolio recommendations.
3. Unclear categorisation
Within the risk descriptions on risk profiling tools, often the categorisation of risk is unclear. Rory commented:
“Descriptions need to be adequately clear for the client to comprehend what the investment journey might look like. For this to be possible, there needs to be some sort of quantification. A view of what the ups and downs will look like.”
4. Capacity for loss
One of the weakest areas for advisers when assessing a client’s attitude to risk is factoring in their capacity for loss. It is important to place a number on this answer, as it is not an emotional response.
5. Reviewing risk profiling tools
During the talk Rory shared several key points from his upcoming report. Released in July, his paper will focus on the six commonly used tools for risk profiling and assesses them against Finalised Guidance 11/5, Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection.
Rory gave some insight into what he has found so far, especially his concerns surrounding ‘middle answers’ and scoring.
6. ‘Middle answers’
‘Middle answers’ are answers where clients are given a series of possible responses across a range from ‘strongly agree’ to ‘strongly disagree’.
When clients don’t understand the question or do not have a view on the answer, they have a tendency to choose the middle option. The middle option however doesn’t necessarily accurately reflect what their risk profile is.
In his analysis, Rory commented
“I will be highlighting cases where people may answer questions in different ways and what advisers can do about it, especially regarding questions that clients may not answer in the right way for reasons unrelated to their risk profile.”
Another significant area of concern is scoring, particularly the way the weights can work for a risk profiler, especially where certain factors fundamentally change the way the scoring is applied.
For example, Rory said he had seen a tool where if the adviser indicated that the client wished to invest for the long term, then an assumption was made that the client was therefore high risk – this is obviously nonsense.
Rory concluded his talk by informing the audience that his guide will highlight what advisers need to consider, and the actions they need to take, to ensure suitability and appropriate disclosure.
“There’s a ‘how to’ element to it, which hopefully will be useful to people.”
Stay tuned for further insights from the event, with a spotlight on specific topics of interest to our readers. We will also share Rory’s guide as soon as it becomes available (with his permission of course!).
If you have any comments or questions, please post in the space below.
This article was created for the DISCUS website based on the Thesis Asset Management event In pursuit of excellence: helping advisers build better businesses. To find out more about their discretionary investment services please visit the Thesis dedicated page ›