With a number of risk profiling solutions on the market, compliance consultant Tony Catt warns of the limitations for those who rely solely on the use of technology to establish a client’s attitude to risk
Over the years, advisers have been in constant pursuit to try and find a consistent means of assessing clients’ attitude to investment risk. For many years, this assessment was simply ticking a box on a scale, where the clients would invariably end up ticking the box that the adviser felt was most likely for them.
Many advisers will remember this type of table on their fact find, the scales may have been 1-5, 1-10 or somewhere in between with broad brush descriptions of risk types, but the ethos was the same.
Typically, clients tended to end up somewhere in the middle as they would want to appear to be sensible people, although every so often there were oddities who would end up at either end of the scales.
Nowadays, the risk descriptions remain the same, but there is rather more detail in the description.
This level of description gives the client some indication of the returns that can be expected at different levels and also the narrative may enable them to identify a level that matches their ideas and attitudes.
So how do we reach the point whereby the adviser is able to help the client to work out what is the correct and most suitable level for them?
This varies from adviser to adviser. Some advisers will have an in-depth discussion with their client, which will involve contemplation of the following issues:
- Assessment of personal circumstances
- Client’s objectives
- Timescale of investment
- Amount of investment, particularly considering overall amount of wealth
- Capacity for loss, including discussion of consequences of certain levels and timings of loss.
- Need to take risk – if modest returns are required, higher risk is not needed, irrespective of the questionnaire risk score.
Limitations of technology
The problem with most questionnaires is that they do not directly ask any of these questions and the underlying algorithms within the programs would not be able to handle the subjective answers that the clients would give.
For the advisers using these, the risk questionnaire gives guidance regarding the most likely risk level and provides a bit of science and possibly some consistency to a subjective judgement.
The use of questionnaire software does provide some consistency to the deliberation of attitude to risk. The accuracy of the questionnaires could be questioned, but they are likely to be statistically likely to be fairly accurate.
Other advisers place greater or even total reliance on the completion of the risk questionnaire. Often the questionnaires are sent to the clients for completion, without any discussion whatsoever from the adviser. So, the advisers take the questionnaire answers, load them into the software and then base all their advice on whatever score the software provides.
I am concerned when I hear that advisers have sent risk questionnaires for completion by the clients themselves. Having observed many adviser meetings myself, I know that even advisers often struggle to explain the thrust of particular questions or the meanings of graphs that appear in questionnaires. If the advisers, with all their experience, are struggling to do this, what hope is there for a client to complete the questionnaire without being able to ask for any explanations?
In this example from an insurance company website, the risk questionnaire is described as follows:
How it works:
- Confirm the extent to which your client agrees with 12 statements about their current situation, feelings and attitude to risk.
- The answers are converted into a score between 1 and 100.
- The score is mapped to one of our seven risk attitude categories. These cover the full range of risk profiles, from very cautious to very adventurous.
- You can then generate a report which confirms your answers and gives you an idea of your attitude to risk.
From some specimen statements, select which of the answers most closely matches your client’s current situation, attitudes and feelings.
- People who know me would describe me as a cautious person.
- I feel comfortable about investing in the stockmarket.
- I generally look for safer investments, even if that means lower returns.
- Usually it takes me a long time to make up my mind on investment matters.
- I associate the word ‘risk’ with the idea of ‘opportunity’.
- I generally prefer bank deposits to riskier investments.
- I find investment matters easy to understand.
- I am willing to take substantial financial risk to earn substantial returns.
- I have little experience of investing in stocks and shares.
- I tend to be anxious about the investment decisions I’ve made.
- I would rather take my chances with higher risk investments than increase the amount I’m saving.
- I am concerned by the volatility of stockmarket investments.
The range of answers for each question is:
no strong opinion
In the example, if a client opts for the 3 in the middle (i.e.no strong opinion), their attitude to risk is likely to be pretty much in the middle. Conversely, if they have strong opinions, then they will appear at either end of the scale. Some questionnaires phrase multiple questions on the same issue, which can lead to contradictory answers being given.
There are some much more detailed questionnaires running to 17 or even 35 questions offered by Oxford Risk or Distribution Technology amongst others. I would presume that the more questions there are, the result should become more accurate.
Risk questionnaires do have a major role to play for the modern adviser business, but mainly because their compliance officers place too great an emphasis on them. They want something on file that gives a consistent, provable result.
The FCA has studied the risk questionnaires and concluded that very few of them are entirely reliable and almost certainly should not be the sole source of risk assessment. They should form a part of the process, but the actual discussion of attitude to risk is too subjective and personal to the clients to be truly, accurately assessed by a computer algorithm.
About Tony Catt
Formerly an adviser himself, Tony Catt is a freelance compliance consultant, undertaking a whole range of compliance duties for professional advisers. firstname.lastname@example.org