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Simon Collins: Risk profiling tools are not the be-all and end-all

The FCA is again pushing the importance of adequate risk-profiling 


The FCA has again stated its expectations of firms in relation to assessing clients’ attitudes to risk and capacity for financial loss.

This is not new news – three years ago the FSA published its guidance in relation to this matter. 

So why is the FCA continuing to discuss this subject at industry conferences?

Not to put too fine a point on it, the industry is still getting it wrong in the eyes of the regulator. 

The FCA’s impatience is crystallised by the number of fines being issued in relation to assessment of risk – some larger firms have been hit with payouts of up to £1.8m while smaller regulated firms have suffered fines of about £20,000.

Indded, the assessment of a client’s attitude to risk is often too formulaic and in some instances is driven by the adviser’s preferred product solution.

What is the FCA specifically concerned about?

Risk profiling: There are many tools on the market. The FSA previously indicated its concern with the way many risk-profiling tools work, but the FCA is also concerned about how they are used by advisers.

There are specific concerns with regards to the weightings applied, the questions asked of the client and an over-reliance on the tool as a replacement for the adviser’s view of the client’s attitude to risk and capacity for financial loss.

In other words, some firms are not assessing the appropriateness of the tool given their business model and target client market, but simply rely on these tools to deliver a one-size-fits-all solution.

Misleading descriptions: The use of poor terminology and complex jargon may lead the client down an erroneous path that could lead to subsequent misunderstandings and unintended outcomes for the client.

Asset allocation: The primary concern of the FCA is the perceived inflexibility within asset allocation models and 

shoe-horning clients into solutions that may not meet the overall investment attitude to risk.

Investment selection: The adviser is responsible for ensuring the selection of investments meets the client attitude to risk and their capacity for investment loss. However, the FCA has found that often the finer details on product risk are shrouded by technicalities and complex and voluminous disclosure.

The FCA is clear the adviser must ensure the product is suitable for the client given the client’s “real” attitude to risk and capacity for financial loss.

  • Does the automated tool allow for flexibility in responses?
  • Is the tool too formulaic? Do you understand how the tool is constructed?
  • Are the questions within the tool contradictory?
  • Do the advisers gather all relevant client information?
  • What happens when the results of the tool do not accord with what the client is telling the adviser?
  • What are your complaints telling you about the manner in which risk is assessed?

If you take one main point away from this article, it should be to remember your assessment of a client’s attitude to risk and capacity for investment loss cannot be determined solely by a risk-profiling tool and these tools must meet the requirements of your firm – that is, be bespoke to the business’s client base and service offering.

Simon Collins is managing director of RGP Compliance



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There are 11 comments at the moment, we would love to hear your opinion too.

  1. Simon; your last point is the most relevant !!

    They are what they are just “tools” (Bit like the FCA and they have offices full of them)

    But does it not make you wonder about the whole delivery of simplified, non advised, automated advice ? I would presume these tools (not the FCA) would have to be a major feature ? and if the FCA have said the vast majority deliver the wrong outcomes, well enough said ! still I expect the FCA task force is well on the case with plain English rules and guidance

  2. I agree with DH about the irony with regard “simplified advice”.

    It is also ironic when you think that NEST “shoehorn” 20 year olds in to low risk investments when it was always the suggestion before that due to the longer term nature of pensions, youngsters should hlean towards higher exposure to equities/shares!

    Both NEST and “Simplified Advice” therefore make a mockery of what the FCA are telling advisers about Risk Profiling “Tools”. The FCA are confirming that “Tools” can be misused by an adviser……. even worse when the tool is misused by a consumer with NO protection or comeback.

  3. Much of this risk profiling is a farce.
    Simple example.
    A little old lady with all she has in the word – £10k. I put it all into the Super Duper Hedge and Emerging and Gold fund with a volatility rating of 200.
    The fund quadruples in value and we cash in. Little Old lady is chuffed to bits. However the advice was totally inappropriate. Will the regulator sanction me? Doubtful.
    Therefore for all this bleating about risk it all boils down to 3 words – “Don’t lose money”. Which in fact is Warren Buffets 1st Rule of investing. (His second is: “Refer to rule one)
    That is probably why they now add “Capacity for loss” – which is also a bit daft – someone may well have the capacity, but I have yet to come across someone who is sanguine about losing any money at all.
    Basically if you can establish that someone is risk averse don’t invest in anything – just keep them in cash and let them see their buying power diminish. You are now in the RDR world so you can charge just as much for this advice than for a portfolio of 20 OEICS. People (who are generally greedy) need to appreciate that if they want to invest – it entails risk. Quantifying this risk accurately is a chimera. Perhaps the best way of mitigation is spread and asset allocation – otherwise known as “The Manure Theory of Money” (Spread it or it stinks)

  4. I’m also with Simon Collins on this. Risk-profiling tools are too simplistic and are so easily mis-used leaving advisers exposed. The FCA’s handbook is quite specific about the requirement for suitability. There is a role for a multi-dimensional questionnaire that forms the basis of a controlled suitability assessment process. Risk profiling on its own is inadequate.

  5. I think we are forgetting one important issue here and that is this stuff is purely and simply for the FCA to be able to beat advisers over the head with a big stick and say that once again we got it wrong, so take a fine and pay the client.
    It is a disgrace for the Regulator to state that some of these profilers are inadequate and produce cr*p but not say which are cr*p and which are suitable. It is only when they come-a-callin’ on firms or advisers will they say “awfully sorry old chap but this is profiler you are using is flawed” do a business review of all your past investment business from the time you started using this profiler and put it right. Hardly what you would cll a forward thinking regulator is it?
    Can someone please tell me why they will not publish a list of the good ones and bad ones? We are all trying to do our best for our clients and it is not helpful that they won’t help us do that by steering us clear of those (who in their view) are flawed. The FCA has obviously spent a lot of time and resource looking into the workings of these – (a lot more than advisers can afford to) to come up with their view but won’t share it with device community? They say they are a consumer champion, wanting suitable outcomes for investors, yet according to the FCA, they “know” which of these profilers are flawed and are happy not to share this. So knowing this information and being the consumer champion why do they not help us get better outcomes for those they are there to protect? IMHO that is coming close to a text book definition of reckless. “Doing something stupid, knowing it is stupid”. i.e. doing something stupid – not telling us which is likely to give us a bum steer, knowing it is stupid – by not sharing their findings it is likely to lead to unsuitable outcomes for clients. Does it get much clearer to being reckless than that I wonder?
    Pathetic really, but that is the life in which we live.

  6. @Harry
    In the example you give there are two points worthy of note. Firstly, the regulator will sanction you – there are numerous examples no customer detriment but systems and control failures that resulted in sanctions and fines. Secondly, the little old lady has effectively been given a one-way bet. If she makes money, great (and you won’t get a complaint as a bonus). If she loses money she can make a complaint and get her money back with interest.

  7. I think the most important point here is contained within a word in the title – ‘Tools’. First, the tool has to be fit for purpose and the FSA, as it was then, found that 9 out of 11 they looked at weren’t. In that instance whatever you do with it is going to produce a poor result – bit like a hammer without a handle.

    Next, you have to know what the tool does and how to use it properly. There are essentially three parts to risk. Risk tolerance (the client’s innate attitude to risk), capacity for loss (the material effect on the client if losses in capital or income occur) and risk required (what they need to take to achieve their objective). The chances of these three matching up is slim to nothing. However, once you have established the three you can have an informed discussion with the client about priorities and agree on the way forward.

    A tool might tell you one or more of these three things. Advisers need to be clear about what it is telling you and how accurate it is. If not then you might be using a perfectly good hammer to try and saw some wood.

    Whatever you do you need to ask whether it is objective, accurate and consistent. Leaving advisres to have a chat with the client risks subjectivity and bias, whether intended or not.

  8. @ Grey Area

    Yes, I well see your point, but doesn’t this rather highlight the stupidity? It assumes that my system didn’t spot she was low risk – or if it did than I lacked control in not steering her away from it – although all the indicators (and perhaps even some insider knowledge!!!!) indicated that she would make a killing.

    E.G. (as an off the wall example) World War 3 starts – gold goes up.
    Basically Little Old Lady should (by Regulatory dictat) have stayed in cash and lost a packet as the currency plummeted as a result of the War. Or Weimar inflation took hold – take your pick.

    There is risk everywhere. Even if you stuff money under the mattress; the risk is burglary. The bottom line is that the Regulator is trying to protect people from loss and in so doing tying itself (and the industry) in impossible knots. I am by no means advocating that we should ignore peoples capacity for loss and their attitude to risk, but we should also recognise that we are often in a can’t win situation.

    Mr Low Risk in a suitable fund making a 2.5% return over 12 months. Just about covers inflation. At the review Mr LR moans that his pal down the road made 14% in Japanese smaller company hi tech stocks. The public soon ignore risk when they are making money and are quick to complain if they are in a seemingly appropriate investment that goes backwards. How much account do the regulators take of this?

    You can’t solve this sort of conundrum with a smart piece of software. Basically the client (and the regulator) needs to understand that: Invest and take a risk or leave your money in cash and potentially take a lesser risk.

    Turning the whole thing on its head – if (say) you had advised a low risk client to stay in cash in the knowledge that roaring inflation was on the horizon – would the Regulator sanction the adviser for that?

    I get the feeling that the regulators make the rules (or perhaps the judgements) as they go along.

  9. @ Harry

    It is interesting to note the terminology you use, e.g. “if (say) you had advised a low risk client to stay in cash in the knowledge that roaring inflation was on the horizon”.

    In that instance there is no risk because you know what is going to happen, likewise with the WW3 scenario. However, the reality is that you don’t know and the degree of uncertainty represents the risk. If I remember my CII risk exams (it was a very long time ago), “risk is the measure of the variation on an expected outcome”.

    When it comes to investment the various different risks you highlight, including staying in cash, should be considered. Individual clients will be willing and able to take varying levels of risk depending on attitude, capacity for loss and objectives.

    Experience would indicate that where risk has been properly assessed and documented and the appropriate investment selected, the FCA and FOS will ignore subsequent performance issues. On the other hand, it’s not always clear what represents acceptable assessment of risk, documentation and matched investment and that is a big issue for firms because it appears to be a moving feast along the lines you suggest.

  10. @ Grey Area

    Precisely. Just make sure all the paperwork is in place, dot the ‘i’s and cross the ‘t’s and CYA at all times.

    Who cares then if the client loses out – you are covered. Anyway risk is also a product of time. All things being equal – the longer you hold an asset the less risk – or the greater chance of profit. Gold is a very volatile asset class. Up till the start of this year it lost money for a good few years. It has now come back strongly – over 10 years you have a decent profit.

    Gold Price

    1/11/11 $1,412
    31/12/13 $1,202 Loss 15%

    30/07/04 $391.80
    1/8/14 $1,291 Gain 229.5%

    It isn’t the individual holdings, but the portfolio in aggregate. If you have (say) £100k then not every fund has to be low risk (for a low risk client). If (say) 2% is in (say) Gold it isn’t going to make the whole portfolio high risk. Anyway as I said previously one of the best risk mitigators is spread. A well spread and diversified portfolio may have a reasonably low overall risk profile (although not easy to quantify) and can within it contain some investments normally held to be higher risk.

    In the end I think you and I are on the same page. The current dialectic is some way from being satisfactory. Yes risk is a vital element to be considered – but how this is done and how much the Regulator is engaged and how much is within the capacity of the ‘average’ client to understand are all moot points.

  11. From my perspective there is a mismatch in the terminology used within the investment sector. The regulator talks about suitability whilst the industry talks about risk profiling. The two are fundamentally different.

    As an investor, my attitude to risk should never be the primary factor for determining an investment portfolio or product. There are more important factors in play; yes capacity for loss but also investment timescales, volatility tolerance, liquidity needs and income requirements amongst others. I might consider myself ‘adventurous’ but my circumstances can dictate otherwise. Any advisor worth his salt will know and accommodate this.

    The great danger for advisers occurs when risk profilers are used blindly or any profile change is inadequately or even not recorded. Risk profiling is not the answer and it offers little to the investor, adviser and regulator.

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