Proﬁling a client
Eighteen months ago, the FSA issued its first consultation paper on assessing suitability and the risk a customer is willing and able to take.
Since then, the industry has experienced an upsurge in the focus on risk profiling; the quality of risk profiling tools has improved, many asset managers now offer risk-profiled investment solutions and in April, the FSA issued further guidance in relation to Central Investment Propositions and risk profiling.
This focus on risk profiling can only be seen in a very positive light. Taking time to understand customers’ needs and wants for their investments should result in better outcomes – that is – more of what they are expecting and fewer nasty surprises.
However, risk profiling tools are designed to support the advice process, not replace it. A good risk profiling tool therefore should be able to enhance the conversations that advisers and wealth managers have with their customers; helping them to answer these six questions:
•How much risk is the customer willing to take?
•How much risk are they able to take?
•Are there any special circumstances that need to be taken into account?
•Does the customer understand and agree with the selected risk profile?
•How well do the selected investments align with the agreed risk profile?
•How will they continue to remain aligned?
Risk profiling tools and services can help firms to provide a robust, repeatable risk assessment process that is easy to do and enables them to follow “good practice”. Think of this as “bridging the suitability gap” from the customer to the manufacturer, through the adviser.
First, the most common way to assess willingness to take risk is by using an attitude-to-risk questionnaire tool. The questionnaire responses help to build a psychometric profile of the customer’s attitude to risk, taking into account factors such as: risk sensitivity, desire for profits, suggestibility and investment experience. However, the results are only the beginning of the risk-profiling process. The next step is to verify the answers given. While a well constructed questionnaire should be an accurate predictor of attitude to risk (a good 20-question questionnaire for example, can have 92 per cent accuracy in predicting that), it is worth remembering that all customers are individuals. As a result, they may provide answers that are not consistent with a single risk profile. Running through the answers, gives the adviser and client an opportunity to explore any areas of concern.
Second, the customer’s ability to take risk should be noted. The results from the questionnaire only record the customer’s willingness to take risk, not how much risk they can afford to take. Therefore, it is equally important to establish how long they intend to invest for and to what extent they may need to use the investment, if they required access to money at short notice.