Risk profiling: what are the options?

Risk profiling: what are the options? In the past few years there has been a trend among financial advisers away from in-house investment selection towards using outsourced risk-targeted funds in model portfolios to satisfy clients’ asset allocation and investment needs.

A recent survey by NMG Consulting showed that advisers are using a range of methods to determine the asset allocation of client portfolios. This includes a self-styled manual approach, in-house developed tools, off the shelf risk profiling tools, product provider and platform portfolio tools and customer fact-finds.

Which method is the best option for your business?

With so much market uncertainty, how will you help your clients feel confident about where and how their portfolio is invested?

Refine your model

Financial advisers are refining their business models, looking in particular at where their fundamental strengths lie and considering whether outsourcing the investment to a professionally managed model portfolio service would better serve their clients.

This is particularly so when managing investments through what looks set to be an extended period of stock market uncertainty and could see advisers having to defend their investment advice to both their clients and the regulator.

By using the resource and experience of a full-time professional investment team, whose sole job is to manage risk-targeted portfolios, advisers can ensure their clients’ investments are being expertly managed.

From a practical point of view, the research and management of clients’ investment portfolios can be both time-consuming and resource intensive. Using outsourced model portfolios not only frees up time for advisers to focus on providing financial advice and tax planning for clients but also to direct more resource into developing the business and building and maintaining client relationships.

Attitude to risk

Key to the whole process, of course, is being able to assess the attitude to risk of the individual client so that advisers can tailor clients’ portfolios to the right risk-targeted asset allocation.

Since every investor is different and can have evolving attitudes to risk depending on personal circumstances, life events and the investment environment, this is never going to be an exact science. However, there are some useful tools around which can be used as part of the advisory process to help achieve a reasonable conclusion in this respect.

Again, NMG Consulting’s IFA Census shows the methods used vary from simple discussions around the fact-find, self-styled manual scoring systems to using product provider templates.

Psychometric risk profiling is an impartial method of gauging an individual’s attitude to risk.

This puts a range of questions to the investor to ascertain their attitudes towards common risks, around capital loss, inflation, investment goals, volatility, liquidity, diversification and counter-party failure, which creates an overall profile and acts as a starting point for an informed discussion about the nature of risk in relation to investment returns and the investor’s own financial goals.

For example, Iveagh uses the risk profiler from eValue FE, which is hosted securely on our website. It is a financial planning tool set enabling advisers and consumers to understand the risk reward trade-off around their investments and financial goals.

The tools use the fully comprehensive functionality of the eValue modelling engine to provide forecasts and cash flow planning. The risk profiler assesses the client’s personal attitude to risk and then summarises the results and suggests a typical asset allocation that might best suit that client.

Diversification

Also important is just how the portfolios themselves are constructed and where they are invested. This underlies the ability of the portfolios to maintain the targeted level of risk.

We believe the only way to achieve effective risk management is to invest in a diversified range of asset classes across global markets and regions together with a disciplined risk management process, so that the portfolios are positioned appropriately to capture growth when the markets are rising and preserve wealth when they are falling.

It is essential that the final decision is made using the complementary resources available and after full discussion with an investor about their personal circumstances, financial goals and investment risk – as part of an holistic financial plan.

Likewise, the client’s attitude to risk must be reviewed on a regular basis to ensure that their investments continue to meet their long-term risk and reward objectives.

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June 13, 2012 < Back