Using risk profiling tools enables a company to have an investment process that is consistent across clients.
These days risk profiling tools are often embedded within wider software. Some tools stop at the risk profiling stage while others have a line of sight from analysis through to a final product recommendation.
The degree of integration into back office systems will be a consideration for some advisers, keeping client data in a single repository.
Product provider tools are available on adviser extranets, typically supporting fund selection from within a set range.
Whatever and wherever the tool is located, the adviser has a duty to understand the functionality and assumptions used within the software solution. Some tools and providers are more transparent than others.
Risk profiling tools are often questionnaire-based, says Vaughan Jenkins, financial services expert at PA Consulting Group. Mr Jenkins says the tool will attempt to map a given attitude to risk against a model portfolio.
There has been considerable debate as to whether these tools are effective in drawing out consumer risk attitudes in a reliable way and Mr Jenkins says questions have been asked about whether the portfolios accurately and suitably reflect the investors’ true characteristics.
There are other complications, he adds, including whether the consumer actually has several rather than one single attitude to risk.
For example, Mr Jenkins says one may think differently about an investment supporting mortgage repayment or funding a child’s education versus a portfolio supporting a more discretionary dream holiday or even a legacy.
On a practical level, he says advisers should ask does an individual really have the ability to respond to hypothetical risk scenarios and how they would react in practice?
Mr Jenkins says: “Profiling tools can be quite blunt instruments in capturing complex attitudes and behaviours and weighing these, via a set underlying of assumptions, to suggest a suitable portfolio.”
But a clear positive of these tools according to Paul Resnik, co-founder of FinaMetrica, is risk profiling is repeatable and documented, usually incorporating some form of client consent.
This is in line with regulator requirements and Mr Resnik says it makes for defensible investment advice and proof of due process leading to suitable and documented investment outcomes for clients.
The potential downsides depend on the quality of the tool you place your faith in.
Assuming the tool is of good quality, Mr Resnik says the negatives can be that the tool is misused, the adviser influences the clients’ responses to the tool, having followed a process the adviser ignores the tool and follows an advice route not consistent with the clients’ preferences and requirements.