Multi-assetOct 17 2019

Painting an accurate picture of a client’s tolerance to risk

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Fidelity
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Supported by
Fidelity
Painting an accurate picture of a client’s tolerance to risk

Multi-asset funds have become a one-stop shop for advisers seeking to diversify their clients’ portfolios, but using these vehicles means grappling with a client’s attitude to risk.

But these attitudes can be shaped by a raft of factors, from their ability to contain losses, to their personal circumstances, future plans and much more.

So how is a client’s attitude to risk determined? 

Questionnaire

Thierry Michel, multi-asset portfolio manager at Tobam, says: “The client’s tolerance for risk is most often expressed in terms of capital losses.”

He adds: “It’s up to the portfolio manager to translate that into a unit they can work with, generally volatility, which remains the most useful metric available for allocation.”

Damian Barry, head of multi-asset multi-management for Mediolanum International Funds, says determining the right solution for each client involves an assessment of their attitude to risk based on a wide range of factors such as risk tolerance, fees, and financial circumstances. 

Andrzej Pioch, multi-asset fund manager at Legal & General Investment Management, highlights that retail clients are often unfamiliar with concepts like standard deviation. 

Standard deviation is a key barometer of risk in finance; the greater the standard deviation, the greater the risk. 

Key points

  • A client's attitude to risk can be shaped by many factors
  • Tools exist to map a client's risk to the correct fund
  • People's capacity to withstand losses can change

“Hence, advisers may need to take a step back and move away from directly discussing risk-return parameters with their clients,” Mr Pioch says. 

He adds advisers may choose to work with independent risk-profilers, who provide them with a short questionnaire that they can use to assess clients’ attitude to risk on a particular scale. 

Number one on the scale represents a low-risk appetite, while 10 shows a client’s inclination for the greatest amount of risk. 

This is echoed by others. Scott Gallacher, a chartered financial planner at Rowley Turton Private Wealth Management, says he determines a client’s attitude to risk in two ways. 

First through the completion of a FinaMetrica risk questionnaire, which assesses the client’s responses and puts the client into one of seven risk categories. 

The second step entails discussing risk and in particular “peak to trough losses”, in cash terms based on the client’s proposed portfolio size. 

Risk composition 

Experts are divided on what the typical risk composition of a multi-asset fund should be. 

Nick Watson, portfolio manager on the UK-based multi-asset team at Janus Henderson, highlights the majority of flows into the company’s Multi-Asset Income range tend to be of a more cautious nature. 

“We have found that the majority of flows into our Multi-Asset Income range have been into clients seeking ‘moderately low to moderate’ or ‘moderate to moderately high’ levels of risk.”

To map this attitude to risk to one of the most commonly used risk profiling providers, Dynamic Planner, this translates to a rating of four or five on their one to 10 scale.

Mr Pioch says: “Different risk-profilers might segment clients differently, but if we think of portfolios that are designed to match their risk appetites we could, for example, label a portfolio of 100 per cent cash as 1, and a portfolio of 100 per cent equities as 10.”

He adds: “In this set-up, most clients often fall in the range from 3 to 7, [so] the risk-profiling exercise allows us to move away from the concept of a ‘typical risk attitude’ and reflect specific circumstances of individual clients.”

Mr Gallacher says: “We use multi-asset funds for a range of risk profiles but typically these are medium or lower risk clients more concerned about preserving what they have.”

Mr Watson says that Janus Henderson has also taken significant flows across the spectrum from low to high risk levels. 

He adds: “In terms of asset allocation, this suggests most clients are suited for an equity allocation from 30 per cent to 60 per cent, which can provide the foundation for a portfolio with complementary bonds or alternative assets to diversify and smooth portfolio outcomes.”

Mihir Kapadia, chief executive of Sun Global Investments, thinks there should be a comprehensive framework in place for risk management throughout the investment process due to market volatility. 

He adds: “From this there will be a much more knowledgeable and positive attitude in place that could create a more appropriate portfolio, which is diversified and has more appropriate risk-return characteristics.”

How risk changes over time 

Research conducted by FinaMetrica in 2019 found that while risk tolerance does not change significantly over time, people’s behaviours and their capacity to withstand losses do change, especially as time horizons shorten. 

So at what points can clients become more risk averse? 

Mr Barry says: “Over time it is likely that a client, working with their financial planner, will move to a lower-risk multi-asset solution as they grow older and their appetite for withstanding market volatility fades.”

Mr Watson says: “Through a client’s investment journey from accumulation into retirement, the anticipated direction of travel would be a decline in risk tolerance over time.”

He suggests there could be a shift in terms of objectives, even if a client maintains a stable ATR. 

“A passively implemented strategy would provide market upside but with a bumpier ride for the client, while more income-focused approaches can smooth returns and provide stable income to supplement the pension income of clients no longer in work,” adds Mr Watson. 

While Mr Pioch acknowledges that a longer time horizon generally means a higher ability to take risk, he highlights that time horizon is just one of many considerations included in a typical risk questionnaire.

“Behavioural biases might also play a role and these evolve through our lifetimes, shaped by our individual experience.”

Mr Pioch adds: “Advisers play a very important role in capturing specific client circumstances that fall outside of a standardised set of 10 or 20 risk questions, and this way they can paint a more accurate picture of the client’s attitude to risk.” 

Saloni Sardana is features writer at FTAdviser and Financial Adviser