Risk profiling link to understanding investors


By Daniel Paperny

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Changes in investor behaviour do not necessarily equate to a shift in their risk tolerance, however emerging entrants in the sphere of risk profiling are often limited and do not always account for this, according to FinaMetrica.

In a blogpost published last week, FinaMetrica co-founder and director Paul Resnik commented on the emergence of several risk profiling competitors such as Oxford Risk and Pocket Risk who he contended based their point of difference around “revealing established views” as wrong.

He said assuming that changing attitudes and investor behaviours were commensurate with a change in their appetite for risk was often “flawed thinking” as the behaviour of investors in situations where a high level of risk was prevalent was not always a function of risk tolerance alone.

“Goals, the perceived risk, the perceived alternatives, the level of trust in an adviser if one is involved will all play a part,” Resnik said.

“Perceptions of risk can change in an instant. Questioning advisers who say that their clients’ risk tolerance has changed usually leads to their agreeing that this view is an assumption based on observed behavioural change.”

One common approach to risk profiling an investor sees the combination of such factors as risk tolerance, risk capacity, time horizon and experience, however Resnik believes questions that blend both of these psychological and financial dimensions should not be asked in unison if an accurate portrayal of an investor and their appetite for taking on risk is to be developed.

“It is well documented that psychological and financial attributes cannot be assessed together. They need to be separated and then mapped to a common parameter so that informed trade-offs can be made,” Resnik said.

“If they are assessed together then the result is an average that is not at all useful to the client or adviser.

“Here's a simplistic example. Someone with a long time horizon and a low risk tolerance will be given the same outcome as someone with a short time horizon and a high risk tolerance and we know that these two clients require different strategies.”

While accurately determining the risk profile of clients was a challenge for the advice industry as a whole, YTML chief executive Kevin Liao noted the problem may be down to a lack of understanding about the tools and technology available to advisers.

Liao said many advisers were struggling when it came to understanding how to optimise advice software – such as risk profiling tools – for their business and this would often result in productivity and efficiency losses.

“It is a common problem in our industry that with limited training, many advisers aren’t equipped in understanding how to get the best out of their software,” he said.

“As an industry, we need to really focus on this issue and solve this problem if we are to progress in delivering a great customer experience.”

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