Do you ever remember using the excuse ‘but everyone else was doing it too’ when caught doing something wrong at school, only for the teacher to retort with ‘well if they stuck their hand in the fire would you do that too?’. At that point you would have to admit you wouldn’t. The interesting lesson here is you know sticking your hand in the fire is a bad idea, so why be influenced by the herd mentality?
The use of cobbled together third-party processes to form a suitability process makes me think of that excuse from school. Everybody is doing it and turning a blind eye to the problems it creates, but hey safety in numbers right? Third-party Risk Profiling tools, provided by unregulated firms, forced together with different investment management processes is a problem. So many things need to align to get a robust process that works. If it all goes wrong, it is the adviser who will be up in front of the headmaster claiming it can’t be their fault as everyone else was doing it too.
Forearmed is forewarned. So, we at PortfolioMetrix have written a whitepaper entitled Risky Business: why the regulator is right to be worried about risk mapping. In it we outline all the areas where you should avoid assuming something is okay, when actually it isn’t:
- The most obvious is assuming the scale labels given to risk-rated portfolios align with the scale labels used in off-the-peg risk mapping tools – they don’t
- The next assumption that could lead to issues is matching the volatility target of the Risk Profiling scale to the volatility target of the Portfolios – they need to use the same risk model for this to work
- The final assumption is that even if the risk profiler firm has done the mapping to the portfolios, that the mapping will not degrade over time – it will unless the investment management methodology matches the risk profiler’s methodology
Be in no doubt that when it comes to suitability, the UK regulator holds advisers responsible for ensuring their clients’ appetites to risk align with the risks taken with the investment portfolio. Using cobbled together third-party processes to form a suitability process is a sure-fire way to getting your fingers burned!