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As such we have seen the rise of model portfolios and centralised investment propositions.

This has been a response by product providers and the wider industry to provide a consistent investment approach that is affordable for clients and profitable for product providers and advisers.

In tandem with the rise of these products, has been the growth of the risk-profiling industry.

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Several providers have emerged that study portfolios and funds to determine their risk profile, and question a client’s attitude to risk. By aligning these two elements, they offer a service for placing your clients in investments that are appropriate for their needs. However, the situation is somewhat more nuanced.

Measure

There is no agreement on how to measure risk and how this should be matched to an asset allocation. Therefore, we see differences in how funds and clients are risk profiled depending on which risk-profiling service is used. There is also the qualitative value that an adviser provides and how this can feed into the service. Finally, the kind of fund that is chosen is also important. I believe that the emergence of all these services and products is a positive development, however it is important advisers apply proper due diligence in choosing a risk profiling service and the consequent investments.

Before moving onto the details of risk profiling, it is important to cover why it is becoming such an important part of the advice process.

The former FSA’s Assessing Suitability paper, published in April 2012, talks about how important it is that a firm ensures that its clients’ investment portfolios match their risk profiles.

Given the need for a fund risk profile, we need to get our heads around what a risk profile is and, more importantly, what it is not. These kinds of ratings are not a guarantee of performance or capital security.

Generally, they are conducted by a risk-profiling company, which looks at the asset allocations and performance to ascertain an estimated volatility, with some even forecasting this over different time horizons. This process can be complex with risk-profiling companies using some proprietary methods and committees to determine risk profiles.

First, from the perspective of testing a risk profile, an adviser needs to recognise there are, generally speaking, three primary aspects to risk in this context:

Risk required – This is the risk associated with the required return needed by a client. If an investor needs to take on added risk in order to generate a required return, this needs to be taken account of and recorded. An adviser should also decide what to alter: the investment or the goal. For example, the client’s investment goals may be totally unrealistic in the given investment environment or risk tolerance.

Risk capacity – This is the extent to which returns can be worse than forecast without upsetting a client’s plans. This is accounting for the unexpected, such as a client outliving his assets, or a return ending up lower than expected and whether the client is able to withstand this. Advisers should model and stress test to account for these events.