TechnologyMay 28 2020

Do risk profiling tools work?

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Do risk profiling tools work?

Third-party risk profiling solutions have grown in popularity and these tools are now used by over 70 per cent of advisory firms, according to Platforum in late 2019.

However, the extent this is completely delegated to online tools varies greatly between firms.

“As a conscious choice we feel there should be some human input,” says Philip Wise, retirement income planning director at Informed Choice Financial Planning.

“We don’t feel that having it all done by questionnaire is right but nor would it be right to have it all done via a chat with a client, we’re trying to have some consistency.”

Therefore, Mr Wise’s team uses third-party risk profile questionnaires as a discussion topic with the client. The concern being, clients may not understand risk profiling – something that resonates with Innovation Finance chairman and former adviser Chris Budd.

“Risk profiling is massively flawed because of various reasons, framing being the most noticeable one,” explains Mr Budd.

“If you ask someone questions about their money while they’re sat in front of an adviser, they‘ll give answers they think they want them to hear.”

Endless questioning?

Ensuring risk profiling speaks a client’s language is an important consideration for many advisers, with Andrew Wheeler, independent financial planner at IFA Eastmills, saying this has made them opt for a simpler solution.

There was one well-known risk profiler we used in the past who had a questionnaire that was 38 questions in total Andrew Wheeler, Eastmills

“We look for something easy and jargon free,” explains Mr Wheeler, who currently uses an 18-question questionnaire.

“There was one well-known risk profiler we used in the past who had a questionnaire that was 38 questions in total. Imagine sitting down with someone to go over that.

“[We are] using something simpler which helps the conversation flow better.”

One business approaching this differently is Multiply, the first Financial Conduct Authority-approved financial advice app.

Multiply, which has an in-house advisory team, does all its own risk profiling which it argues allows it to use its own tone of voice to suit the app’s target market (those who have fallen through the advice gap).

Unlike others, Multiply makes a conscious effort to remain removed from the risk-profiling process, leaving it to the user to agree their own final risk score.

A spokesperson for Multiply says: “As long as it is positioned correctly, there should not be much need for adviser interaction on risk-profiling. This can lead to unintended bias.

“Flagging rules help us identify cases where further clarity around their risk profile is required. We then communicate and clarify where required via email.”

However, when this journalist – after creating an account on the app – submitted a question to the advisory team (concerning the adviser/AI split working on the plan) a response was promised within a week’s time.

Room for improvement

Back in 2010, the then-Financial Services Authority assessed 11 risk profiling tools, finding nine to have “serious” shortcomings.

However, by 2017 things had improved, with former FCA technical specialist Rory Percival at the time producing a report that noted: “[Risk profiling tools] have evolved quite noticeably since the FSA did its work at the beginning of the decade.

"At the time, it tended to be just standalone risk profiling tools, but now they are much more integrated.”

However, there still seems to be room for improvement. For instance, some advisers are wary of the ultimate accuracy of risk-profiling algorithms in how they capture individual circumstances.

“Many risk profiling tools assume an individual's ‘risk tolerance’ is fixed and invariable,” says Amyr Rocha-Lima, partner at Holland Hahn & Wills.

“I’d argue it rises and falls with the prevailing market trend.

"Financial planners know that the same client will give you wildly different estimates of their ability to withstand ‘risk’ at different times. The danger lies in accepting an investor's own estimate of their ‘risk tolerance’ as it will usually be an unconscious call on the current market.”

The regulator is also wary, writing a ‘dear CEO’ letter to the advice industry in January 2020. Among the issues highlighted was suitability of advice, which has forced providers to refocus their offerings.

SimplyBiz is one such provider, with a new service to be rolled out in 2020 responding to concerns about how risk profiling works for retirement plans.

Dan Russell, managing director of SimplyBiz Investment Services, explains: “It’s noticeable the majority of financial planning tools and risk profiling processes are entirely based on long-term growth assumptions and these are not necessarily a model you would use if you were taking an income in retirement.

“We will shortly be revealing retirement-income optimised planning processes and asset allocations that allow advisers to specifically choose a retirement-income optimised approach with very different concepts of risk, where sequencing of returns and coverage ratio are much more significant than long-term volatility.”

Paul Resnik, co-founder of Finametrica, bought by Morningstar earlier this year, also sees room for improvement and is concerned risk profiling is being used to sell products rather than strengthen service.

“You want to construct a proposition where the client can make an informed decision, you cannot just use the algorithm to give advice,” he says, adding he has had poor experience working with larger advice organisations with “mechanical and commoditised” DFM propositions.

Mr Resnik elaborates: “As you go up to institutional advice, it tends to become more mechanical. My experience is they look at my 25-question test and say no clients will want to fill that in.

“My response would be it will be the basis of the relationship and strengthen their understanding of the advice needs.”

John Yarker is a freelance journalist