The fundamental definition of risk being lost in translation in the investment process remains very real following this month’s Money Marketing survey results.

Risk profiling a client, and subsequently recommending investments that employ different definitions of risk, is problematic. The issue lies in mis aligning the recommendation to the client’s needs and desires, leading to future regulatory sanction and client redress.

More than 10 per cent of advisers from more than 260 surveyed by Money Marketing on 1 November said that they used one company for the risk profiler and a different one for the risk-targeted funds. Eight per cent, or one in 10, said they had no standard process for measuring a client’s attitude to or capacity for risk prior to that. I suspect they may have been the same people, but we didn’t get to see that level of granularity.

Our CEO Ben Goss, commenting on this month’s survey findings, told Money Marketing, “The FCA wants people comparing apples and apples. It doesn’t matter what tool, it should be the same for the investment and the investor. The FCA might look at that eight per cent and ask questions.”

62 per cent of advisers surveyed said that they bore the main responsibility for ensuring investments remained in line with the client’s risk profile and agreed mandate. 22 per cent, in comparison, felt asset managers shouldered that fundamental burden.

It is perhaps not surprising then that advisers have increasingly recommended Risk Target Managed (RTM) solutions in Dynamic Planner in the last 12 months. New figures out in October 2018 revealed that RTM recommendations were up 15 per cent year-on-year compared to October 2017 data. The recommendation of Premium and Select-rated funds in Dynamic Planner also increased, 30% year-on-year. It makes sense that if you use the underlying assumptions in Dynamic Planner to risk profile your client, you’ll use the same assumptions for the asset allocation and recommendations. Nothing will be lost in translation.

Premium and Select-rated funds highlight investments with strong five and three-year performance, respectively. When it came to choosing an RTM solution in the Money Marketing survey, advisers underlined that returns delivered for the risk taken after charges was the most important attribute, closely followed by staying within the risk boundaries over a given period. When advisers were asked what were the key benefits of RTM funds, ensuring ongoing suitability ranked first followed by managing client expectations. All things we hear time and time again from Dynamic Planners.

The 6,500 advisers and paraplanners who use Dynamic Planner select from more than 120 RTM solutions and Dynamic Planner RTM funds under management have grown rapidly from £1.6bn in 2013 to £6.7bn in 2018, or 320 per cent. We are proud to be spearheading this change.

Ben Goss told Money Marketing, “Data on risk-targeted solutions shows the area is expanding. It goes back to the FCA’s question of how you ensure good value for money. Advisers are receiving the message and engaging with clients to get them to understand it’s about assessing the return for the risk being taken. Investment and investor just have to be aligned; we’ve seen that in the Financial Advice Market Review.”

“It’s difficult to argue that with professional targeting you are not going to get a good outcome. But blending risk-target solutions could be a bit self-defeating. Managers are taking particular allocations and tactical decisions based on their own view of risk. As long as these decisions are made within the risk profile, they are not necessarily visible to advisers.”

Dynamic Planner was founded in 2003 and is the UK’s most popular risk profiling and asset allocation investment process. It helps you and your firm ensure your clients’ investment suitability, increase efficiency and demonstrate value. Crucially it ensures nothing is lost in translation between risk profiling a client, building a risk-based financial plan, creating an asset allocation-based investment strategy and recommending suitable investments. All that translates into suitable, compliant outcomes both for you and for your clients. Learn more.

In the dark days pre-RDR, firms might ask whether a client was high, medium or low risk. If they gave the middle answer, the client would be prescribed a ‘balanced’ fund made up of a mix of asset types: cash, bonds, equities, and property.

As with any population, most people fall in the middle of the distribution and balanced products sold well. Insurers and banks created huge funds into which the majority of investors were advised or sold.

Over the last decade, the industry has professionalised. That said, the ‘balanced’ mentality still persists and it is dangerous, not least because there is no clear definition of what it is or what outcome you might expect from a ‘balanced’, multi-asset investment. The FCA references this in its Asset Management Market Study and is looking at how fund objectives can be improved for investors.

The Investment Association operates three categories which might tick the ‘balanced’ box: Mixed Investment 0-35% Shares, 20-60% Shares and 40-85% Shares. These are hardly clear definitions of the manufacturing process, let alone of the outcome that an investor might expect. It also means that the equity element, the riskiest part, can vary a lot within a category and indeed over time, changing the investment’s risk profile.

On a finer grained risk spectrum with 10 risk profiles, where one is cash and 10 is volatile emerging market equities, a ‘balanced’ portfolio might take you anywhere from a relatively cautious three out of 10, where only 25% is invested in equities, to seven out of 10 with 70% in equities.

Why does this matter? Well, in a prolonged bear market – a one in 20 series of events – a fund with a risk profile of three (following Dynamic Planner’s target asset allocation) might be expected to fall by around 18% over five years, whereas one with a risk profile of six might fall by 28%. Exceptional times for sure, but if the investor exits at the wrong time on a fund of £100,000 that is an additional loss of more than £10,000. If the client is retired, that is a 10% hit to their income. If they are working or looking to retire, that is another few years they need to remain doing so. It is also potential redress for the firm.

Equities are not the only asset class to involve risk, arguably all assets do, including cash where clients face the almost certain risk of losing money in relation to inflation over time.

More scientific analysis of a portfolio as part of a rigorous and consistent investment process, in which the investor is assessed on the same basis as the investment, will help you understand the nature of the risks clients face in combination.

If your firm still thinks of investors as ‘balanced’, here are three questions worth asking:

  1. Can we be more specific – on a scale of one to 10, where would each client fall?
  2. What is the value at risk these type of investments represent in a bear market and is this a good match for each client?
  3. Is it likely that the risk profile of the investment might change over time?

If you are not happy with the answers you reach, get in touch to discuss how Dynamic Planner’s Investment Process can help.

Ben Goss,

Dynamic Planner CEO