Advising lower risk clients

The recent UK Government Bond crisis has resulted in some quite significant drops in pension valuations against a highly volatile and inflationary backdrop. What makes this latest market shock unusual is that investments deemed to be lower risk have been hit the hardest due to their higher bond allocation.

This has tested the theory that bonds are low-risk or more appropriate for clients approaching or in-retirement and created a conundrum where lower risk has become the new higher risk.

Amongst the spiralling cost of living crisis, how can advisers alleviate client concerns and what steps can they take to help deliver better outcomes for risk-averse clients?

Managing client concerns

Engage and educate your clients - One of the primary reasons risk-averse clients are often placed in lower risk strategies is they don’t have the appetite to ‘stomach’ market falls so naturally, this latest crisis has triggered concerns.

In this context, it’s important to engage and educate clients who lack investment expertise or confidence. That doesn’t mean educating clients on how bond yields interact with interest rates, but providing reassurance on how this crisis is due to lower risk investments’ exposure to bonds which have been severely spooked by the measures announced in the Government’s ‘mini-Budget’. This can be very technical, but it’s important to clarify that there are specific reasons for this drop.

There’s no doubt that market volatility is also a significant issue for clients looking to retire shortly. This can be exacerbated if they want to move assets into cash and effectively crystallise their losses, highlighting the real value of ongoing advice in this turbulent environment.

Encourage income flexibility - Drawdown clients taking regular income from their plan will already be feeling the bite of higher inflation and heightened volatility. Drawdown investment strategies tend to have a higher bond allocation relative to accumulation strategies (particularly those at the lower end of the risk spectrum) with the intention of being more resilient in market shocks. The effect of the latest crisis on these solutions would have come as a big surprise for clients in these strategies and can have a detrimental impact on income sustainability.

So how can income sustainability be preserved by lower risk clients? If they can afford to, it’s a sensible move to limit the amount of income being withdrawn. In addition, don’t be afraid to discuss reducing current and expected levels of expenditure with clients, as this can improve income sustainability over the longer-term.

What practical steps can advisers take?

Review your investment solutions and processes – Lower risk multi-asset solutions with a broader range of assets have fared better than basic solutions using an equity and government bond split during this inflationary period. . These aren’t sufficiently diversified to weather inflationary conditions and market shocks.

Having a more diverse spread of assets has the potential to help maximise risk-adjusted returns in a wider variety of market conditions. For example, our multi-asset solutions have exposure to commodities and commercial property which have supported performance during this inflationary period. Adopting a truly diversified solution and highlighting how broad diversification can deliver good client outcomes could help you evidence how your products and services deliver fair value under the upcoming FCA consumer duty regulations.

It’s also useful to think about the benefits of active management in challenging market environments. Active strategies can be used to help clients navigate the investment landscape rather than purely following the benchmark. They can also be used to add incremental value as market opportunities arise –something which can’t be achieved with passive strategies. We use active management in our multi-asset solutions to add value by tactically adjusting exposure to different assets as the business cycle evolves. For example, we’ve already tactically reduced our exposure to various fixed income strategies.

Dialling up risk

Increasing a client’s risk level, and therefore reducing overall exposure to bonds, is one way to potentially generate higher returns, but is this suitable practice and how would they feel about an increased exposure to risk during periods of higher volatility?

To earn higher returns, you must be willing to increase exposure to higher-risk investments. This may yield higher returns over the short and long-term, but will almost certainly yield periods of greater underperformance too - an undesirable outcome for many.

This comes back to engaging and educating clients. A lack of investment education can lead to individuals choosing lower risk solutions, so it’s imperative to continue supporting and educating clients by building conversations around taking more risk into your advice processes.

Does lower risk = vulnerability?

One of the consumer duty outcomes is ‘consumer support’. This is about how clients interact with a firm’s products and services. Part of this is making sure firms have procedures to support vulnerable clients. You could argue that risk-averse clients are vulnerable clients (now even more so!) who need support through periods of market stress. Do you have processes in place to respond to queries, offer support and capture concerns and outcomes? Thinking about it from the client perspective will not only help you get ready for these new requirements, but also help you provide a better client experience.

Read more from Royal London’s investment experts on our adviser website.