Hitting the target: How advisors are matching investments to their clients’ risk profiles

Hitting the target: How advisors are matching investments to their clients’ risk profiles

Experts are calling on advisors to take a more consistent approach when matching risk profiles to investments as Money Marketing research shows there is still a lack of consensus among firms over what process to follow.

Some advisors are using different risk measuring techniques for different clients, our survey suggests, as well as varying methods over how they make sure the funds they select stay aligned with that risk.

Wrestling with risk

More than 260 advisors responded to a Money Marketing survey about how they mapped attitude to risk to an actual investment recommendation.

Just under half said they always used a third-party Attitude to Risk (ATR) tool to start with – a higher proportion than comparable advisors in the US, Canada, and Australia, according to FinaMetrica director, Paul Resnik.

A quarter said they always used an in-house tool, while 17 per cent said they used a combination of both. Resnik says: “It surprises me that in-house suitability tool development and application continues despite the regulatory obligation to regularly undertake due diligence on all tools used in the advisory process.

“I suspect it would be only the larger advisory enterprises that would have the enthusiasm, competencies and resources to maintain the integrity of their suitability toolkit.

“The others are adding risk without any significant benefit. The range of approaches to tool selection reflects the differing awareness of the importance of due diligence.”

Thirteen per cent said they used a risk-based, cashflow forecast to assess capacity, and the remaining 8 per cent said they had no standard procedure for ATR and this varied based on the client. Dynamic Planner chief executive Ben Goss says this might raise concerns with the regulator. He adds: “The FCA (regulator) wants people comparing apples and apples – it doesn’t matter what tool, but it should be the same for the investment and the investor. The FCA might look at that 8 per cent of people with no standard procedure and ask some questions.”

The most common way of translating this ATR into an appropriate investment was for advisors to combine model portfolios or individual funds independently to match the risk themselves, based on a reading from the same profiler used with clients. Half of the respondents said they employed this method.

However, risk-targeted funds were also a popular solution. Some 21 per cent independently chose specific risk-targeted funds based on the ATR tools’ output. One in 10 opted to choose these risk-targeted funds using a third-party research service (i.e., not the same risk profiler that was used with clients).

Fifteen per cent chose risk-targeted funds based on their own investment risk analysis, while 13 per cent opted to outsource all decisions over how the investment solution should account for the client’s risk level to a discretionary fund manager.

Of those using risk-targeted funds, 90 per cent had either independently reviewed the market or reviewed it with the help of a consultancy to make at least part of their selection. Resnik says: “There is a growing understanding of the need to objectively assess tool strengths and weaknesses and build processes to mitigate against those weaknesses in the advisory process. This should be paramount not only in the minds of advisors but also the managers in their firms, in light of the impending senior managers regime.”

Serenity Financial Planning uses its own model portfolios for its clients. Director Tina Weeks says the firm decides which of these is most appropriate for a client’s risk tolerance by getting an output from a risk-profiling tool, then overlaying this with the financial data it has about the client, as well as life planning elements regarding what they want to do with their money.

Weeks says: “Sometimes it’s very different to the one the risk profiler would give, but when you understand the client well enough, you can deviate. You shouldn’t be wedded to a risk-profiling tool; you can use your expertise and conversations with clients over the whole relationship.”

Priorities for risk-targeted funds
When it came to what they cared most about with regards to risk-targeted funds, advisors placed returns delivered for the risk taken as the most important factor in selection, after charges. Asked to rate a number of criteria on a scale of one to five, where five was most important, this averaged 4.09. Having a track record of delivering within the risk profile was rated next highest, at 4.05, and having a diversified asset base was next most important, at 3.89.

Advisors cared less about having a respected fund manager brand (3.37) and low volatility around the risk level (also 3.37). The main benefits of risk-targeted funds, as advisors saw them, were to help ensure ongoing suitability (3.98) and helping to manage clients’ expectations for future meetings (3.62) – slightly ahead of the potential benefit that they could deliver better risk-adjusted returns than other fund types (3.36).

While nearly half of respondents said risk-targeted funds offered sufficient diversification, 36 per cent were still unsure.

Steadying the ship

As for responsibility for making sure investments stayed aligned to risk, advisors were clear the primary duty lay with them. Some 62 per cent said advisors should be mainly responsible, compared to 22 per cent who thought it should be fund managers.

Those who thought fund managers had responsibilities noted “it’s always important to check that fund managers stick to their remit”, and the fund should be kept in line with the risk mandate, even if advisors must ensure the overall portfolio suits the risk level on an ongoing basis.

One said: “The level of risk required is a mixture of attitude, as measured by a risk profiler, required – as measured by financial assets, liabilities, inflows, and timeframe on both the accumulation and decumulation periods in the client’s financial plan – and capacity, as measured by assets and inflows. Getting the balance is down to the skill of the advisor. This also emphasizes the importance of regular planning meetings.”

Some advisors said they mandated their multi-manager and multi-asset fund managers to be active and rebalance daily. One noted: “We have responsibility. However, if using a risk-rated fund, the fund manager should stick to that output, thus they are responsible. If they get it wrong, then the advisor will change it.”

However, another said: “As an IFA, I think it’s unlikely that a fund house would listen to me moaning about the composition of the fund. All I can do is monitor performance.”

I have been using FinaMetrica for over 17 years for onboarding new clients. They like the extensive value of the reports; but what we appreciate is the innovations in technology, the value of the client-facing materials and the development of the life-long client relationships as I get to really know their behavioral tendencies. FinaMetrica has assisted me in building a very successful practice and we highly recommend it for any advisor who wants to enhance the overall value of their client relationships.

Ron Wilkinson - Portland, Oregon, USA
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