Investments  

Matching client risk appetite with ESG preferences 

  • Describe how advisers can establish their clients' ESG preferences
  • Explain why this is important
  • Identify what greenwashing is
CPD
Approx.30min
Matching client risk appetite with ESG preferences 
Photo: Clay Banks/Unsplash

Investor curiosity about the issues that fall under the broad environmental, social and governance banner is not a new phenomenon.

 

But it has increased significantly over the past couple of years, with a collection of factors helping fuel greater demand for information, data and solutions that can help investors align their long-term savings with their principles.

What has also developed rapidly is the supply of products and services available to those investors. On the face of it, that should make life easier for advisers, but it also adds to the challenge when considering ESG preferences in the wider risk assessment context. 

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Of the respondents to an EV survey of consumers in March 2021, 94 per cent said that at least one of the ESG factors was essential or very important, with only the remaining 6 per cent saying it was not necessary to them at all.

That helps explain why research from the lang cat found that advisers expect ESG to account for almost half of all recommended assets by 2026, and why, according to NextWealth, the vast majority of advisers now consider ESG an important part of the know-your-client process.

Indeed, advisers are now required to take clients’ sustainability preferences into account in their assessment processes.

MiFID II and the Insurance Distribution Directive included amendments to this effect: “To enable investment firms that provide investment advice and portfolio management to recommend suitable products to their clients, those investment firms should introduce in their suitability assessment questions that help identify the client’s individual ESG preferences”. 

Defining risk 

The regulatory focus on suitability has sharpened over the past decade, making the process of defining risk more integral than ever.

Only by defining risk properly can you be sure of full risk alignment and of delivering advice suitable for meeting the clients’ goals.

This is about considering client objectives – particularly their income and/or growth goals and how the client will need to invest in order to reach them – and the scale of risk that should be matched to their risk profiles. 

Advisers also need to keep in mind the methodology for defining the risks of the proposed investments and how the risk questionnaire being used was created and tested.

Psychometric risk questionnaires can play a vital role here by ensuring the questions asked of a client are pertinent to their specific objectives. 

The questions can take a variety of approaches, including: 

  • Direct self-assessment
  • Emotional response to risk
  • Past behaviours
  • Scenario

Importantly, by covering beliefs, attitudes, emotional response to risk and past behaviours, among other factors, a sophisticated psychometric questionnaire has the ability to highlight inconsistent responses or results.

An adviser who can clearly state a client’s risk in a way that accounts for their goals, capital and appetite for risk will invariably be better equipped to provide relevant, holistic advice for their financial future and recommend the appropriate options for their clients’ needs and risk profile.