Investors and advisers are exposing themselves to a ‘ticking time bomb’ by using risk-profiling tools, The Platforum has warned.
The investment and distribution consultancy says some firms are overly reliant on risk-profiling software and argues some tools are biased toward risk tolerance over capacity for risk.
In May, the FCA urged firms to provide transparent explanations for different risk profiles and highlight clearly the risk of making a loss. It prompted Distribution Technology to respond in a column for Money Marketing.
In 2011, the regulator found that 9 of 11 tools reviewed had problems which could result in “flawed outputs”.
In its Stickman fund distribution report, published today, The Platforum says: “We have seen advisers developing or buying in risk-profiling questionnaires that are not fit for purpose. Some questionnaires are wholly focused on testing tolerance of risk and ignoring capacity for risk.
“The FCA has taken issue with the quality of some tools on a number of occasions, as well as advisers’ over-reliance on tools in lieu of having proper and explanatory conversations with clients. There are grave concerns over suitability if the logic of the tool is flawed.”
It also highlights the possibility that layering in multiple different risk-profile tools through the investment chain creates mis-matches.
The report says: “If an adviser or discretionary manager is mapping a client’s risk score to a multi-manager fund from one provider plus a model portfolio from another it can be a risky business.
“To achieve the right mapping, there needs to be very good visibility on how the profiling questionnaire works as well as how the end solutions work – both often closely-guarded secrets for commercial reasons.
“Consequently, assumptions get built into the mapping process. This could well be a ticking time bomb for investor outcomes.”
It adds that during research for the report some multi-manager firms expressed doubts about the long-term viability of risk-ratings over risk-targeting.