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Hitting the target: How advisers are matching investments to their clients’ risk profiles

Experts are calling on advisers to take a more consistent approach when matching risk profiles to investments as Money Marketing research shows there is still a lack of consensus among firms over what process to follow.

Some advisers are using different risk measuring techniques for different clients, our survey suggests, as well as varying methods over how they make sure the funds they select stay aligned with that risk.

In recent years, there has been a growth in risk-rated solutions – funds that have been assigned a rating, normally by an external agency – but also risk-targeted funds, where managers have a specific mandate to keep investments within a defined risk boundary. According to Square Mile, there are now around 150 funds that fall under the risk-targeted banner. Risk profiler Dynamic Planner says its risk-target managed funds have grown from £1.6bn in 2013 to £6.3bn this year.

But have these developments helped advisers ensure their investments are the right ones for clients?

Wrestling with risk

More than 260 advisers responded to a Money Marketing survey about how they mapped attitude to risk to an actual investment recommendation.

Just under half said they always used a third-party ATR tool to start with – a higher proportion than comparable advisers in the US, Canada and Australia, according to Finametrica director Paul Resnik.

A quarter said they always used an in-house tool, while 17 per cent said they used a combination of both. Resnik says: “It surprises me that in-house suitability tool development and application continues despite the regulatory obligation to regularly undertake due diligence on all tools used in the advisory process.

“I suspect it would be only the larger advisory enterprises that would have the enthusiasm, competencies and resources to maintain the integrity of their suitability toolkit.

“The others are adding risk without any significant benefit. The range of approaches to tool selection reflects the different awarenesses of the importance of due diligence.”

Thirteen per cent said they used a risk-based cashflow forecast to assess capacity, and the remaining 8 per cent said they had no standard procedure for ATR and this varied based on the client. Dynamic Planner chief executive Ben Goss says this might raise concerns with the regulator. He adds: “The FCA wants people comparing apples and apples – it doesn’t matter what tool, but it should be the same for the investment and the investor. The FCA might look at that 8 per cent of people with no standard procedure and ask some questions.”

The most common way of translating this ATR into an appropriate investment was for advisers to combine model portfolios or individual funds independently to match the risk themselves, based on a reading from the same profiler used with clients. Half of the respondents said they employed this method.

However, risk-targeted funds were also a popular solution. Some 21 per cent independently chose specific risk-targeted funds based on the ATR tools’ output. One in 10 opted to choose these risk-targeted funds using a third-party research service (i.e. not the same risk profiler that was used with clients).

Fifteen per cent chose risk-targeted funds based on their own investment risk analysis, while 13 per cent opted to outsource all decisions over how the investment solution should account for the client’s risk level to a discretionary fund manager.

Of those using risk-targeted funds, 90 per cent had either independently reviewed the market or reviewed it with the help of a consultancy to make at least part of their selection. Resnik says: “There is a growing understanding of the need to objectively assess tool strengths and weaknesses, and build processes to mitigate against those weaknesses in the advisory process. This should be paramount not only in the minds of advisers but also the managers in their firms, in light of the impending senior managers regime.”

However, 15 per cent said they had created their own in house. A quarter said a DFM had had at least some involvement in selecting the risk-targeted funds that clients used.

Serenity Financial Planning uses its own model portfolios for its clients. Director Tina Weeks says the firm decides which of these is most appropriate for a client’s risk tolerance by getting an output from a risk-profiling tool, then overlaying this with the financial data it has about the client, as well as life planning elements regarding what they want to do with their money.

Weeks says: “Sometimes it’s very different to the one the risk profiler would give, but when you understand the client well enough, you can deviate. You shouldn’t be wedded to a risk-profiling tool; you can use your expertise and conversations with clients over the whole relationship.”

Rohan SivajotiAdviser view

Rohan Sivajoti
Director, Postcard Planning

We use EValue and generally Vanguard Life Strategy after that. We look at the underlying asset allocation that would be supported by the attitude to risk and see which maps closest to Vanguard. It seems to fit; when you use Life Strategy it automatically rebalances so you don’t come away from the risk boundaries. If you want 60:40, it will be 60:40.

If the mandate is unconstrained, it can be difficult to recommend to your clients because it can walk away from the place agreed with them. If the asset allocations shift from their risk appetite and someone makes a complaint, they might have grounds for that.

Priorities for risk-targeted funds
When it came to what they cared most about with regards to risk-
targeted funds, advisers placed returns delivered for the risk taken as the most important factor in selection, after charges. Asked to rate a number of criteria on a scale of one to five, where five was most important, this averaged 4.09. Having a track record of delivering within the risk profile was rated next highest, at 4.05, and having a diversified asset base was next most important, at 3.89.

Advisers cared less about having a respected fund manager brand (3.37) and low volatility around the risk level (also 3.37). The main benefits of risk-targeted funds, as advisers saw them, were to help ensure ongoing suitability (3.98) and helping to manage clients’ expectations for future meetings (3.62) – slightly ahead of the potential benefit that they could deliver better risk-adjusted returns than other fund types (3.36).

While nearly half of respondents said risk-targeted funds offered sufficient diversification, 36 per cent were still unsure.

Expert view

Hunt for good value fuels rise of risk-targeted solutions

All the data on flows into risk-targeted solutions shows the area is expanding. It goes back to the FCA’s question of how you ensure good value for money. Advisers are receiving the message and engaging with clients to get them to understand it’s about assessing the return for the risk being taken. Investment and investor just have to be aligned; we’ve seen that in the Financial Advice Market Review.

You can see a pattern here: some firms are outsourcing to a multi-manager, others are saying it’s up to the DFM. But they are still expecting the DFM to operate within risk boundaries, which is very positive. Use of third-party tools clearly dominates, and it’s really positive about the proportion of people using risk-based cashflow. Over the years, that’s been a lot lower, probably in the single digits.

Most advisers still offer an advised portfolio, and that’s adviser added value through manager diversification. But if you have a good manager, they are very capable of delivering the risk mandate. It’s difficult to argue that with professional targeting you are not going to get a good outcome.

But blending risk-target solutions could be a bit self-defeating. Managers are taking particular allocations and tactical decisions based on their own view of risk. As long as these decisions are made within the risk profile, they are not necessarily visible to advisers.

Ben Goss is chief executive of Dynamic Planner

Steadying the ship

As for responsibility for making sure investments stayed aligned to risk, advisers were clear the primary duty lay with them. Some 62 per cent said advisers should be mainly responsible, compared to 22 per cent who thought it should be fund managers, 13 per cent DFMs and 3 per cent risk profilers.

Advisers had a range of justifications for this. For example, a restricted adviser said the responsibility fell on the advice network when investments were on its panel.

Those who thought fund managers had responsibilities noted “it’s always important to check that fund managers stick to their remit”, and the fund should be kept in line with the risk mandate, even if advisers must ensure the overall portfolio suits the risk level on an ongoing basis.

One said: “The level of risk required is a mixture of attitude, as measured by a risk profiler, required – as measured by financial assets, liabilities, inflows and timeframe on both the accumulation and decumulation periods in the client’s financial plan – and capacity, as measured by assets and inflows. Getting the balance is down to the skill of the adviser. This also emphasises the importance of regular planning meetings.”

Some advisers said they mandated their multi-manager and multi-asset fund managers to be active and rebalance daily. One noted: “We have responsibility. However, if using a risk-rated fund, the fund manager should stick to that output, thus they are responsible. If they get it wrong, then the adviser will change it.”

However, another said: “As an IFA, I think it’s unlikely that a fund house would listen to me moaning about the composition of the fund. All I can do is monitor performance.”



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There are 5 comments at the moment, we would love to hear your opinion too.

  1. Is it not about income also? Equities/Investment Trusts release dividends and isn’t income what everybody in retirement is after; to support their ‘extras’ in their lifestyle, as a necessity or to gift away for IHT mitigation? (Gifts out of income are exempt).Income without selling capital (next year’s income) may be the way to go with UK equities not carrying as much risk as overseas equities? (Exchange rate risk, EM risk, Political Risk)?
    At the end of the day, surely if you are getting your required monthly income, what happens in the stockmarkets is historically only a temporary ‘blip’? ( A bit like a BTL really)?

  2. Blimey, there are some scary results in here. 25% use in-house tools, only 13% use cash-flow planning for capacity for loss. It would be intetesting to see figures for risk profiling and capacity split out. Are most firms just using the capacity for loss section of a risk profiling tool for capacity? If so, they are not meeting FCA requirements.

    A guide to risk profiling tools, risk profiling and capacity for loss would be useful here …..

    • Indeed, scare stories seem to abound too…

    • cashflow planning has its place but for Mr & Mrs Average, cashflow planning is easily achieved without the need for detailed cashflow software. Money in, money out and a bit left over at the end. Same every month. Cashflow planning software outputs are treated as the holy grail by some. However, I have lost count of the times people show me the outputs of a previous adviser cashflow projections that failed to be kept up to date and were not even close the reality that occurred.

      There is certainly a place for software based cashflow planning but not for the mainstream consumer. So, I suspect the 13% were talking about software cashflow planning. The rest doing forward planning without using cashflow software.

  3. Rebalance daily?? That’s completely absurd. The cost will totally overwhelm any possible benefit.

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