Using a risk profiling tool should mean you have done all you can to ensure your clients are getting the investment solutions they require, right? Wrong.
There are many pitfalls involved in using risk profiling tools that appear to offer peace of mind but which, in reality, can result in investment decisions that are entirely different to what you – and your clients – expected.
It’s a topic we’ve raised on a number of occasions in the past, including a white paper (Risky Business) that covers this issue in detail (you can download it here). It was raised more recently in an article in New Model Adviser (you can read that here).
What’s the problem?
As any financial adviser knows, taking the right level of risk for clients is crucial to achieving the desired outcomes. It also reduces the risk of redress if clients feel they have been mis-sold an investment. Yet the way different investments map to different risk profiling methodologies can leave advisers struggling to deliver the expected outcomes for clients.
Unless you have a consistent definition of risk from start to finish, there’s a clear danger of risk misalignment at some stage of the advice process and the investments may not perform as you expect
Assumption is the mother of all…
Using an independent (unregulated) risk profiling tool often means advisers have to make assumptions.
The most obvious is assuming the scale labels given to risk-rated portfolios exactly align with the scale labels used in off-the-peg risk mapping tools – they don’t.
Another incorrect 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 incorrect 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 very likely will unless the investment management methodology matches the risk profiler’s methodology.
The solution?
Use a risk profiling tool that has been designed to work alongside specific investment portfolios. This will give ultimate peace of mind.
