Indeed, the regulator has demonstrated its continued commitment to risk management and the ongoing assessment of product suitability through the second round of the Markets in Financial Instruments Directive – Mifid II – which came into effect at the beginning of the year.
Further, the ground swell in popularity of multi-asset solutions led the Investment Association to launch its Volatility Managed sector last year to house the raft of outcome-focused products that have been created to meet this trend.
In theory, this should assist advisers in being able to draw comparisons across various products and provide greater transparency as to whether funds are delivering on their stated targets. It marks the latest step in the evolution of risk profiling and implementation, a process that is vital to the success of this sector but is not always easy.
The big change has been in allowing advisers to do that assessment. Jim Henning“The nature of risk profiling is that it is multi-faceted and we need to take time to understand the various components,” explains Andrew Harman, senior portfolio manager, multi-asset solutions at First State Investments.
“We have to balance the attitude to risk, the investment horizon and the changing balances of the portfolio over time. We also have to have a clear understanding of the clients’ underlying goals, as well as their liquidity needs.
“In addition, when having those conversations with clients, advisers can be faced with someone who wants a high return but low risk. There can also be a difference in perception as to what constitutes risk. A good example of that is the current situation with cash, which can actually be seen as being risky as it is offering a very low return and purchasing power can be compromised.
"Equally, asset classes such as US equities may have the potential for greater short-term volatility but could offer a higher return over a longer time period. It is a case of getting the balance right for the individual client and updating that risk profiling over time.”
From simple questionnaires to an integrated approach
For Jim Henning, principal consultant at Dynamic Planner, it has been interesting witnessing how the risk profiling process has changed and developed over time. He has seen a move from relatively simplistic questionnaires to a more integrated approach to assessing risk appetite and applying that to the multi-asset solution that is provided to meet the clients’ needs.
“Initially risk profiling tools only went so far, looking at the psychology of the client in the form of psychometric analysis but failing to adequately take into consideration the client’s capacity for risk,” he says.
“While they may have a high appetite for risk, they may not have the capacity to take on that level if they need to access that money or if they can’t actually tolerate losing the money if things don’t go according to plan.
It will become easier for advisers to choose the optimum product to deliver their clients’ needs. Rob Thorpe“The big change has been in allowing advisers to do that assessment and then being able to dial up or dial down the solution based not just on attitude, but also the suitability and capacity for risk of the individual. It is not just about blindly following a black box."
He adds the industry now also has things such as cash-flow modelling, which Mr Henning describes as "the ultimate reality check". He explains: "It looks at how likely it is that the client will achieve the cash flow required and can be a real wake-up call on the level of risk someone is able to take on.”
Evolution of the market
Mr Harman adds: “The move within the industry to more closely align multi-asset products to the investment objective of the client has been an important development. Rather than relying on long-term averages, investment houses are building products that are not just trying to outperform the asset class indices, but more closely map the end-investors’ needs.
“In addition, the risk-rating agencies have evolved. They are now putting in more qualitative analysis too. They are not just number crunching; there is a deeper understanding of what funds are offering.”
Meanwhile, Rob Thorpe, head of distribution, intermediary, UK at BMO Global Asset Management, highlights the fact advisers can have a greater sense of confidence in multi-asset solutions as time passes and the market evolves.
“Advisers are able to use risk-profiling tools and make clear recommendations based on the results,” he says. “Our funds, for example, have proven they can deliver upon expectations even over a turbulent time in terms of market conditions.
There are always going to be short periods when the funds will be outside of the parameters set for them, particularly when there are black swan events or sharp corrections but, if the adviser chooses a quality fund, they benefit from the long-term experience of the managers to be able to deliver over time and not have knee-jerk reactions to short-term market movements.
“As funds within the sector establish longer term performance figures, it will become easier still for advisers to choose the optimum product to deliver their clients’ needs.”
Overall, the level of commitment the industry is demonstrating towards multi-asset solutions, namely in the creation of a dedicated sector and a plethora of fund launches, shows that this is a trend that is set to continue.
However, while risk-profiling has evolved, there will undoubtedly be more work done on finessing the process, combining both art and science in ensuring that the tools and solutions deliver upon expectations.
Laura Mossman is a freelance financial journalist
