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Ian McKenna: The future for risk profiling tools

Ian McKenna MM blog

When it comes to discussions over the art or science of financial advice, few subjects elicit more passionate debate than risk profiling.

Last year the FSA rightly, if somewhat abruptly, highlighted the importance of not just understanding how a client feels about risk but the extent to which they have the capacity to take risks and particularly the importance of understanding and articulating the downside should the risks taken result in losses.

This week FinaMetrica, one of the most popular risk profiling suppliers in the market, begins to rollout a new version of its software. Amongst the key changes in the new version of the system are greater highlighting of the differences in responses from each risk group. This helps more focused conversations between adviser and client which can result in a more decisive instruction from the client to the adviser of their risk tolerance.

This is particularly valuable in the resolution of differences between spouses. Typically women are less risk tolerant than men. Differences often result in conflict and tension unless resolved.

Research by FinaMetrica has also identified that invariably couples will almost never have the same attitude to risk making it important for the adviser to demonstrate how they have balanced conflicting perspectives.

The historical illustrations of portfolio performance have also been significantly enhanced in the latest version. There are now 11 portfolios rather than seven previously, each ten per cent growth assets apart.

Each portfolio illustration has been increased from one to five pages providing advisers with a rich choice of examples to share with clients. A new section is provided on inflation, as well as illustrations in real and nominal terms in both pounds and percentage. A new savings illustrator and analysis now includes a comparison of the last 10 years and the last 40. The section has added graphics and narrative.

The goal is to help clients make better decisions in relation to portfolio risk and minimise the likelihood of the client being surprised by his portfolio’s behaviour over time.

Ultimately, the role of a risk profiling tool, and other related tools that can form part of an adviser’s suitability process, is to drive discussion between the adviser and client.

I especially like the way in which the new FinaMetrica service clearly identifies where answers provided by the client conflict.

The FSA has made it clear that the way in which advisers first identify then explore and document the conclusions they have reached with clients in such situations will be a key part of what it is looking for in client files.

As in so many similar issues it is important not just to have had the conversation but to have clearly documented it together with the conclusions reached and the consequent action agreed.

A more detailed summary of the new features can be found in the quick start guide to version 2.0 and I would also encourage advisers to read this risk and return guide which provides a fascinating backwards view of how portfolios consistent with risk tolerance and would have behaved over the last 40 years.

My understanding of the current FSA requirements is that advisers are expected to properly understand the workings of the systems they are using so that actually the adviser is giving the advice, rather than a black box within a software system.

In my experience what really distinguishes FinaMetrica from its competitors is its willingness to engage in dialogue to aid understanding of how its system works. This is in stark contrast to a couple of their competitors who I have found invariably seek to draw a veil over what actually goes on inside their “black box”.

Earlier this year the company produced a valuable white paper summarising what it has learnt over the previous fifteen years of working with clients in twenty different countries.

There are equally passionate debates around the benefits of psychometric risk profiling tools compared with others. If an adviser is going to use a non-psychometric tool this raises the question of how they will measure its accuracy? Where a psychometric tool is selected it is important that the supplier provides clear confirmation that it is valid, reliable and accurate and produces unambiguous evidence to demonstrate this.

A technical manual should also be available to anyone who wants to have a greater understanding of the detailed working of the system. Again this is an area where I have found information from other risk profiling tool suppliers sadly lacking.

Our own soon to be published benchmarking shows that in terms of an end to end solution several of the partnership implementations of FinaMetrica such as Plan Plus and Voyant deliver a more comprehensive overall solution than the stand-alone product but either way there is no questioning the strength of the underlying risk profiling engine.

Ultimately it is down to individual firms to decide if they prefer a standalone risk profiling tool and to discuss the other related issues such as a client’s capacity for risk separately or would prefer this to be integrated with a wider range of tools as part of the advice process.

Whichever way you want to go this latest iteration of the FinaMetrica tool is a welcome move forward for the market.

Its continuing openness and transparency alone make a strong case for FinaMetrica to be the first solution any adviser should consider for risk profiling and its competitors would do well to adopt an equally open position.

To prove this, try asking any of the other suppliers for documentation with the level of detail provided in those highlighted above. You may find yourself waiting a long time.

Ian McKenna is director of the Finance & Technology Research Centre


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There are 4 comments at the moment, we would love to hear your opinion too.

  1. Surely part of the answer to this conundrum of risk vs reward is in the hands of the product providers.
    They are uniquely placed to not only understand the risks associated with their various asset classes and sectors, they have a duty of care to mitigate downside risk, whilst increasing the potential for growth.

    The old With Profits model is probably the best example I can think of which put the emphasis on smoothed returns, rather than volatile inconsistent returns and the new surfeit of Unitised WP funds now available through major providers can do the same job, so why do advisers think they can do better than WP fund managers?

    Beats me, if one looks at how an FTSE 100 index tracker fund has done in the last 10 yrs and compare that with the returns provided by the best Unitised WP fund (we all know which provider beginning with P, that is) then the WP investor has won out.

    EG – Best WP provider total return over last 10 yrs 84.1% net of charges

    A typical FTSE 100 index tracker fund total return over last 10 yrs about 16.5% (estimated)

    No brainer really

  2. “The old With Profits model is probably the best example I can think of which put the emphasis on smoothed returns, rather than volatile inconsistent returns and the new surfeit of Unitised WP funds now available through major providers can do the same job, so why do advisers think they can do better than WP fund managers?”

    Because they’re not completely cretinous? Most WP funds have performed appallingly, and the only way any people made any money was because the insurer made promises they couldn’t wriggle out of despite the appalling performance.

    With a very few exceptions, of course. But if you believe advisers can’t do any better than the NPIs and Scottish Mutuals, whence comes this faith that they can guess which With Profits provider is going to be the best over the next ten years, without the benefit of your hindsight?

    As for a ‘typical’ FTSE 100 tracker returning 16.5% over ten years – the FTSE 100 is up 44% over that period. And then you’ve got ten years’ worth of compounded dividends on top of that. Who’s running your tracker fund? Robert Maxwell?

  3. Ned, you’ve compared the best WP fund against a typical tracker fund which as a fellow poster quite rightly points out excludes reinvested income too.

    Can we turn this around and compare a typical WP fund against the UK Equity fund?

    Would the last IFA recommending WP please turn out the lights?

  4. Whoops, should have read:

    Can we turn this around and compare a typical WP fund against the BEST UK Equity fund?

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