Your IndustryMay 9 2013

Attitudes to risk, capacity for loss

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The guidance confirmed that the customer’s capacity for loss was their ability to “absorb falls in the value of their investment” and if the loss of capital would have a detrimental effect on a customer’s standard of living.

The determination of a customer’s capacity for loss is an important part of the overall attitude to investment risk assessment: how much can they afford to lose before they become worried, are unable to sleep at night, or are continually calling you? As we know it is far more complicated than this as each customer is going to be different. It is all very individual and subjective.

Conduct of business sourcebook 9.2 requires advisers to take account of a customer’s preferences regarding risk taking, their risk profile and ensure they are able financially to bear any related investment risks consistent with their investment objectives.

There is no ‘one size fits all’ solution in determining a customer’s risk profile and capacity for loss, it has to be a combination of tools: questionnaires, open questions, closed questions and complete engagement.

Another consideration is how long can the loss prevail as some customers’ capacity for loss will not accept short-term losses above their agreed capacity for loss and therefore not allowing the markets to ‘bounce back’. Other customers may accept losses above their capacity if it is short term while others may accept that the investment will need time to recover. It is all very subjective.

Therefore the customer’s different time horizons, both long and short-term losses, are a critical assessment which has to be clearly established. Another area to consider is if the client is a very cautious investor and whether the effect of inflation on their investment is an acceptable loss they are willing to accept.

This type of information needs to be carefully collated in order to accurately determine the outcome of the risk discussions with the customer and it will only come from full engagement with them.

In many ways it is about managing a customer’s expectations. What is the investment anticipated to do? How much is it likely to fluctuate and is this within the customer’s capacity for loss tolerance, short and long-term expectations and overall risk profile?