Traditional risk profiling practices, whereby clients are characterised according to their stated risk tolerance preferences, are outdated and new approaches need to be reflected in regulations affecting advisers, delegates to an ifa roundtable have said.
“Traditional risk profiling has not kept pace with compliance, right through to FOFA – it’s a real problem,” said SFG private client adviser Jamie McKay. “Having real flexibility is really difficult [under traditional risk profiling] because if you have a client that has a ‘highly conservative’ risk profile off the back of a questionnaire, it might result in an outcome that is a disaster for them in terms of their goals.”
Mr McKay added that since the global financial crisis, many financial planners have been determining asset allocation strategies in line with “their own fears” of non-compliance, rather than with the client’s best interests.
van Eyk head of asset consulting Jonathan Ramsay agreed that a more “nuanced and complex” understanding of risk profiling from the regulatory authorities was needed to ensure asset allocation and portfolio construction are being conducted in the clients’ best interests.
“The most compliant portfolio out there is 70 per cent in fixed income with no real chance over three to five years of achieving a CPI plus two per cent outcome – so the compliance is making people do things that just don’t make sense,” Mr Ramsay said.
According to Omniwealth senior financial planner Andrew Zbik, this is an issue the whole industry – not just forward-thinking individual advisers – should bring to the attention of the regulator, so “they can build in that flexibility we all desire”.
Tim Mackay of Quantum Financial said that if risk profiling means “asking a few multiple questions” and determining asset allocation strategy off the back of it, this is insufficient, but that risk profiling is still a useful tool in better understanding and developing rapport with clients.
Does compliance hinder best practice asset allocation? Have your say below.
There are many risk profiling tools available but any of them are only the entry point to profiling. Our own skills, communication and client interaction support the end outcome. The issue can be the lack of ongoing reviews of the profiling. yes, if you work within the FPA guidelines ( as an example) and apply your social science skills-end of problem. Strategy counts-the funds are only the tools to achieve desired outcomes, but nothing stays the same forever, good regular communication is essential and act accordingly.
Clients will always be growth investors in bull markets and conservative investors in falling markets, no amount of “risk profiling” will change that.
What does need to change is the discussion about whether the change in markets (up or down) has impacted on the likelihood of achieving long term goals. Then assess the impact to the client, logically not emotionally. Yes they need to endure the journey otherwise the plan will fail.
What is needed are better tools to enable a more informed discussion with clients, that are more fact based and have solid foundations.
There are a few out there doing this, but not many, most dealers don’t know or don’t care. Admittedly they are struggling to stay solvent under waves of regulation….I wonder why innovation has stalled???
Falling prey to ones emotions when investing is a no no. Get scared and selling at the bottom or getting greedy in a bull market and consequently straying outside the objectives….that is what risk profiling should be….a discussion about sticking to the plan, not mushy questions like “how did that make you feel…” and “what would you do if……” pointless questions that interfere with the advisers solutions and give FOS and ASIC ammunition to pin losses on the adviser rather than acknowledging that an investor has instead succumbed to emotional factors that have stuffed up the plan. Rogue advisers aside….there should be no risk profiling questionnaire at all….just a discussion paper on the relevant risks in plain writing. Investor accepts the recommendation…..that is all.
A good risk test provides the basis for discussion between adviser and client about the portfolio that best meets the clients’ needs and circumstances. The Asset allocation consistent with risk tolerance, which is a psychological trait, needs to contrasted with the asset allocation that meets the clients’ financial needs and circumstances. This is the conversation to be held. the goal is to have the clients’ informed consent to the risks in their portfolio and plan.
I would agree that Australian regulation in this matter is out of time and step with best practice in other juristictions. haveing said this the FOS view is more contemporary
It doesn’t really matter which way you splice it guys, a conservative or growth based asset allocation can be deemed “not in the clients interests” in the opinion of ASIC even if the client directly asked for it! Why? Because there are so many ambiguous grey areas in FOFA law that not even ASIC knows how to interpret or apply them, so if they don’t like you then they cut you off and use one of the many grey areas in FOFA as the cause of your “breach”
Determining an appropriate asset allocation is a combination of at least 3 things:
Required rate of return
Risk disposition
Risk’s to a client’s position including sensitivity to asset returns being well under that which is required.
***many financial planners have been determining asset allocation strategies in line with their own fears of non-compliance, rather than with the clients best interests***….summed up nicely.