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Mark Polson warns on model portfolio risk-ratings

Mark Polson 480

The Lang Cat principal Mark Polson has warned advisers not to rely on discretionary fund managers to accurately match their risk ratings with those from risk profiling tools when using model portfolios.

The FSA published its final guidance on replacement business and centralised investment propositions in July, covering the use of model portfolios, distributor influenced funds and DFM services.

The guidance states: “Where a firm creates or uses risk-rated portfolios as part of its Cip, it must ensure the portfolios align accurately with the risk descriptions and outputs from any risk profiling tool it employs.

“It is the responsibility of the firm to ensure this alignment. Where there is a misalignment, there is a risk of systemic misselling.”

Speaking at the Institute of Financial Planning’s annual conference in Newport last week, Polson (pictured) said this statement represents the “biggest risk point” for advisers.

He said: “We often see the adviser asking the DFM to map their portfolios onto FinaMetrica, for example, and it comes out with a result and that is great. But you need to know why, how does one risk-rating map to another risk-rating, and that needs to be recorded.”

Polson said advisers need to be able to explain how a risk rating 2 from a DFM equates to a risk rating 4 from a risk profiling tool if the regulator asks.

He said: “That is not the responsibility of the DFM, and it is not the responsibility of the tool provider, it is your responsibility, and it is a really big one. That is not well understood yet.”

Equilibrium Asset Management investment manager Mike Deverell says: “Assessing risk is a complicated process, as is outsourcing. There is a lot more to it than simply hoping a risk questionnaire has been appropriately mapped to a portfolio.”

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Comments

There are 2 comments at the moment, we would love to hear your opinion too.

  1. Without wanting to diminish the Lang Cat’s analysis, might I suggest that an equally important risk point is the initial risk assessment.The whole process of Mapping from the clients risk tolerance score to a portfolio which in turn must be tested against likelihood of matching clients needs and risk capicity is fraught with risks. Mitigating those risks is where the art of financial planning comes into play. There is, of course, greater likelihood of planning success when advisers use the most robust science available to them in the first place when assessing the clients risk tolerance. Even if the Adviser chooses not to use a psychometric tool they should have made some attempt to assess their preferred testing tool’s Accuracy, Validity and Reliabilty. They have both a professional and now an FSA set obligation to do so. Failure to undertake that assessment would seem a trifle naive. Putting both the plan and the planners business at risk. At a recent industry symposium 48% of the 90 advisers in the room said they were using a risk profiling tool that they had designed themselves. We all know about GIGO.

  2. Even if you get the risk mapping part right, how do you control the level of risk that the portfolio manager is taking. Many MPS providers like to advertise that their managers have the flexibility to move a portfolio entirely to cash if they feel that market conditions dictate. Well how is your balanced investor going to feel if the manager gets that calll wrong. Your client was willing to accept a certain level of risk and the commensurate reward for it but the manager that you as his adviser recommended chose to radically de-risk the portfolio so that he was invested in an entirely unsuitable portfolio? Any MPS worth its salt must have restrictions in place so that no action takenby the manager/provider can radically alter the risk/reward integrity of any of the portfolio.

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