Expert: Paul Hogg, Head of Distribution, 8am Global Facilitator: Michael Lawrence, Principal Consultant, Bovill
Headlines:
- Risk profiling tools and questionnaires can have limitations such as poorly structured/worded questions, scoring, and/or risk descriptions
- Advisers need to understand the weaknesses of the tools they use and factor those into the wider risk-profiling process
- Translating conceptual descriptions of risk into tangible outputs that clients can understand is a key advisor skill. It is important to discuss in relation to lifestyle, priorities, income needs over time
- Mapping products and asset allocations to risk levels is challenging. For example, historical volatility may not indicate future risk, and products labelled as ‘cautious’ aren't always low risk
- Behavioural biases can impact risk assessment. This applies to both consumers and advisers
- Managing client expectations on risk and volatility is crucial, especially after a long bull market
- Education and cash flow modelling can help provide perspective
- There is an increased regulatory focus on how firms demonstrate risk as part of suitability, especially for retirement advice
Discussion points:
The roundtable discussion covered the challenges around defining and assessing risk for clients in financial advice as well as the limitations of risk profiling tools and questionnaires, the difficulties in matching investment solutions to risk profiles, the differences in risk assessment for accumulation and decumulation, the behavioural and emotional aspects of risk, and the need for advisers to have soft skills to translate risk into tangible meaning for clients.
The delegates also noted the trend towards more personalised risk frameworks, the regulatory pressures around risk suitability, and the importance of managing client expectations on risk.
Key points included:
Limitations of risk profiling tools and inherent biases
The group discussed how risk profiling tools and questionnaires have limitations such as poor design and scoring methods. Their outputs should be used as a starting point for adviser discussions rather than strictly dictating recommendations. There are also inherent biases in adviser-led risk assessments, with potential unconscious influencing of client responses.
Challenges in mapping products and asset allocations to risk
Participants noted issues in mapping investment products and model portfolios to specific risk levels. Historical volatility may not capture future risk, and "cautious" labelled products aren't always low risk in practice. Scrutinising propositions is important.
Different risk frameworks may be needed for accumulation and decumulation
The group explored how risk can have different dimensions in the accumulation and decumulation phases. Looking at metrics like income at risk may be more appropriate for retirees.
Importance of soft skills in translating risk conceptually
Advisers need strong soft skills to translate conceptual risk into tangible meaning based on each client's lifestyle priorities and income needs over time. This was seen as a key part of the role.
Regulatory pressures around demonstrating risk suitability
Suitability requirements and the increasing focus on client outcomes as a result of the Consumer Duty regulations require firms to robustly assess and demonstrate risk as part of suitability, especially for retirement propositions.
Managing client expectations on risk and volatility
The behavioural aspects make managing client expectations around risk and volatility crucial, especially after an extended bull market. Education and cash flow modelling can provide perspective.
The session discussed the challenges around defining and assessing risk for clients in financial advice. It covered the limitations of existing risk profiling tools and questionnaires, the difficulties in matching investment solutions to risk profiles, the differences in risk assessment for clients in accumulation and decumulation, the behavioural and emotional aspects of risk, and the need for advisors to use their soft skills to translate risk into tangible outputs that clients could understand.
Key takeaways:
- Review risk profiling tools used and identify any gaps or limitations
- Ensure asset allocations and product mappings to risk levels are robust (i.e. not just based on historical volatility but forward-looking stochastic analysis)
- Consider implementing tailored risk assessment frameworks for accumulation and decumulation client segments
- Ensure advisors are trained on soft skills for translating risk into understandable outputs during conversations with clients
- Document risk suitability assessment process in detail to meet regulatory requirements
- Consider incorporating client education and cash flow modelling to improve client understanding and manage expectations
