The context of risk

Investment suitability is high on the global regulatory agenda. In this exclusive interview, Ian Cornwall, director of regulation at the UK’s Personal Investment Management & Financial Advice Association, asks Daryl Roxburgh, global head of Bita Risk, how wealth managers can really satisfy suitability requirements, while also maintaining investment choice in an increasingly multi-asset world.

Ian Cornwall (IC): What is your assessment of all the different risk-profiling tools on the market? Are there any questions wealth managers should be asking but aren’t?

Daryl Roxburgh (DR): Many tools are based on psychometric tests that assess the individual’s attitude to risk in isolation but we seek to do something different. We believe you should first of all explain risk, second, seek a common understanding of risk and third, look at risk in the context of the particular aim and objective of a given portfolio. People have different acceptance levels for risk depending on their goals.

‘THERE ARE FIRMS USING ASSET ALLOCATIONS PROVIDED BY SOFTWARE VENDORS AND THEY HAVE LITTLE REAL UNDERSTANDING OF THE ASSUMPTIONS MADE OR THE PROCESS USED’

Someone who considers themselves a risk taker may want to limit risks on a child’s school fees portfolio, for example. They have to pay those fees and so require a high degree of certainty of being able to achieve that goal. In contrast, a pension portfolio may have 20 or 30 years to run, you can afford to take on more risk because your ultimate time horizon is very long.

IC: Are there any questions wealth managers don’t ask of software providers that they ought to?

DR: Yes, many! First, how does the questionnaire output tie in with the investment proposition?

Second, are the questions relevant to the real-life objectives of that client? By that I mean asking whether it is for the client’s long- term pension or a short-term reserve, not if it is balanced or growth.

Third, do the questions help the client understand risk rather than just being a tick- box exercise?

Fourth, and perhaps most important, does the tool integrate with the firm’s investment process, giving it control and ensuring the tool is consistently applied? There are firms using asset allocations provided by software vendors and they have little real understanding of the assumptions made in them or the process used. You have to ask how they can be sure they are taking the client down the right path.

They have ticked the box and give the impression of doing so but there is no real connection between the questionnaire answers and the suggested portfolio.

Phrases such as scientific and stochastic process are bandied about but there is a distinct lack of comprehension or an ability to question or explain.

‘YOU WANT TO SLEEP AT NIGHT, SAFE IN THE KNOWLEDGE YOU ARE DELIVERING TO CLIENTS. IT’S ABOUT LIVING YOUR MARKETING MESSAGE’

IC: What’s the direction of travel here? What kind of developments are wealth managers asking for?

DR: Many wealth managers are seeking what we call a ‘four-eyes review’, where if you want to vary the profile of a client from the questionnaire output, it needs to go through a quality assurance process. Self-completion is also a trend, where firms want clients can complete a questionnaire electronically and update their manager prior to their annual review. We are doing a lot of work on integrating with portals and client relationship management systems.

We predict ‘gatekeeper’ questionnaires could be another big development, given the

number of firms that are launching portfolio services with smaller thresholds. There are a series of questions clients must answer before proceeding to the main profile questionnaire. If the client is unable to answer yes to all of the questions, the gatekeeper flags up that they are probably in the wrong place.

IC: What do you think the regulators should be focusing on in their suitability drives?

DR: The key thing is making sure that questionnaires are constructed and expressed well, ensuring firms are challenging conflicting answers and making sure the client really understands what you mean by risk.

There must be an element of constructive challenge back to the client, which is something I do not see currently being provided by robo-advisers. Many seem to be passive recipients of data and the danger is that we end up with a two-tier market in terms of suitability that is unacknowledged.

I believe the regulator should segment its approach according to the level of interaction the client has with the firm giving the advice.

 If I was being controversial I would say you should have one set of rules for those people who spend a substantial amount of time with the client and understand them, a second set of rules for remote completion of data and a third for self-determination or ‘robo’.

IC: So that speaks to firms defining early on what their service is and making it clear they are collecting data in that context.

DR: The firms that have done well are consistent in saying ‘This is what we do; and this is what we don’t do compared with other providers’. If you are the CEO or the senior manager you want to sleep at night, safe in the knowledge you are providing the service the board and investment committee want you to deliver to clients. It’s about living your marketing message.

IC: Clearly, we want to avoid a complete homogenisation of the industry as oversight tightens. How can firms stay within the lines but still deliver their investment philosophy and differentiate themselves?

DR: Again, it comes back to the context of the firm and client. We live in an increasingly multi-asset world as investors are turning to alternatives to meet their income needs. For instance, there is a real trend towards socially responsible investment at the moment.

All our clients use our tool differently. We want firms and investment managers to have the freedom to make their selections but provide them with a robust foundation for how portfolios are constructed and monitored for suitability on an ongoing basis.

Best practice is about consistency in how investment decisions are made and the documentation process, rather than the curtailment of choices managers and clients can make.

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