How many risk profiles should an MPS have?

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How many risk profiles should an MPS have?
(Ylanite Koppens/Pexels)

Risk is a defining characteristic of model portfolio services, with their ability to cater to usually at least five different risk appetites.

“It may be more practical and convenient to select an MPS provider who can satisfy and provide a risk solution across all risk levels,” says Chris Jones, proposition director at Dynamic Planner.

“With MPSs, the adviser does need to engage with the MPS provider, and this additional step makes it more typical to use the entire range.”

Where a MPS’s objective is to operate within a stated risk profile or framework, Jones adds that a risk-profiling provider should ensure that advisers are confident a client is still invested appropriately.

Indeed, risk profilers and MPSs are forming an increasingly symbiotic relationship, says 7IM senior investment manager Tony Lawrence.

“The effectiveness of the investment proposition is reliant on the risk profile being correct, while the risk profile is meaningless without a portfolio that is in alignment,” he says. “Together, they are vital components in ensuring the long-term financial goals of clients are delivered.”

Matching clients and portfolios

Additionally, if the investor’s suitable risk level has not been determined accurately, any matching of portfolios will be ‘garbage in, garbage out’, says Greg Davies, head of behavioural finance at Oxford Risk.

“Make sure that the client’s risk profile is measured properly using a stable psychometric assessment of risk tolerance, plus holistic consideration of their risk capacity, which comes from considering their overall financial circumstances.”

Understanding clients’ objectives, such as growth or income, as well as the term of their objective, should be taken into account when mapping MPS portfolios to client risk profiles, says Andrew Storey, proposition director at EV, which risk-rates portfolios.

Any measure of the risk of the portfolio that is sensitive to short-term market moves is unlikely to be able to match investors properly.Greg Davies, Oxford Risk

"Term is important as the shorter the term, the higher the volatility of either income or growth tends to be. Therefore, check that your risk measure can provide you with the term-related features of risk," says Storey.

"An income-based objective should be focusing on the risk of changes in sustainable income over time, whereas the accumulation stage for a product will focus instead on the fund value itself."

From the investment side meanwhile, Davies says it is crucial that the risk of a portfolio is measured using a long-term, stable risk measure.

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