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Consultant warns on risk-return communication

Advisers should be questioning the effectiveness of how they communicate risk to clients, with ASIC targeting advisers in its 2014/2015 surveillance program, says FinaMetrica.

The risk profiling consultancy said ASIC is concerned by gaps in the area of consumer financial literacy, which includes keeping track of finances, planning ahead, and understanding risk and return.

FinaMetrica co-founder Paul Resnik said the government has also increased its focus on the advice profession and that many  firms are beginning to review the quality of their advice and the way they explain risk to clients.

Mr Resnik said financial advisers often rely on risk and return illustrations produced by the financial services industry to explain risk to clients.

These risk and return illustrations often downplay risk, he said, particularly the likelihood of outliers or rare events, while focusing on upside potential.

“The end result is that many clients take on more risk than they are naturally comfortable with, or are over-exposed to risk and don’t understand the risks they have taken,” he said.

Mr Resnik said advisory firms must have policies and procedures in place to ensure that customers' needs are at the heart of their business and that their advisers comply with their legal obligations.

“ASIC has acknowledged in its Strategic Outlook that weak compliance systems and poor cultures, as well as vertical integration, can compromise the quality of financial advice,” he said.

“An adviser’s conflicts of interest and lack of competence can lead to investors being advised to buy products which are not suitable taking into account their needs and risk preferences.”