Risk is on everyone’s lips. And whilst it might seem risky to pen this email after a late night at the Corporate Adviser Awards, I will do my best. Clients who went in to drawdown at the dawn of the pension freedoms may now be faced with a pension pot worth about 20% less. Equities seem a risky bet but the alternatives appear unappetising.
One of the challenges advisers face in assessing risk is how to ensure the risk profile they establish for a client matches the investment solution that they recommend – especially if the investment function is outsourced. Assessing a client’s risk profile is one of the most challenging things an adviser has to do – but it can be doubly difficult if two different organisations are involved.
This is one of the issues that a group of DFMs, providers and advisers discussed at our Investment Strategy Forum that we ran with Square Mile on Monday. It was one of the more contentious topics of the day.
Assessing a client’s risk profile is inherently difficult. Measuring people’s feelings about risk involves skill and sensitivity.
Even if we accept that the risk questionnaires can be effective for assessing clients’ psychological risk tolerance, they barely deal with clients’ risk capacity issues – establishing how much a client can objectively afford to lose. And capacity to take on risk can rise or fall according to a client’s circumstances. Age, health, income, wealth and family situation can all change and affect the extent that someone can afford to make risky investments.
Pretty well all advisers and DFMs agree that risk questionnaires should just be the start of the conversation between the adviser and the client.
But then there’s the gap – between the investment portfolio the adviser has decided the client wants and needs and the actual portfolio he/she will get.
Part of the problem is the well-known limitations of backward looking assessments of investment performance and volatility. Currently advisers, DFMs and providers mostly say they are nervous of the bond market. Some admit to being “terrified” by it. So one of the core components of classic asset allocation solutions of the last few years is arguably in a very different place from where it has been for at least two and a half decades. Many DFMs are using other – hopefully low risk – asset classes, which may or may not behave as expected.
And then there’s the worry that advisers may assess their clients correctly – but could get their assessment of the portfolios provided by outsourced partners horribly wrong. It is, as one DFM put it, a matter of mapping the client’s profile onto the portfolio’s profile. That is a reasonably simple process if the adviser follows the risk-profiling tool strictly. But it gets more difficult once other issues – like risk capacity – are introduced. And in any event advisers may use, say Finametrica’s questionnaire, while the DFM may benchmark themselves against Distribution Technologies – or the other way round. They may even use a completely different process!
With turbulent markets, clients might be feeling increasingly edgy as they see their investments falling further than they might have expected. So the space between expectations and performance is already moving out of the academic realm into the practical world. Mind the gaps!
We will be covering model portfolios on platform in our forthcoming Fund Distribution Guide and will also profile the major DFMs offering model portfolio solutions. Get in touch if you’d like to share your views or to be profiled.