Ian Stott, client services director at The Consulting Consortium, gives his views on what constitutes best practice when it comes to risk-profiling clients.

Ian Stott, client services director at The Consulting Consortium, gives his views on what constitutes best practice when it comes to risk-profiling clients.

Client risk-profiling is the subject of a forthcoming WealthBriefing research report produced in association with Advent entitled Beyond Box-Ticking: Leveraging Enhanced Risk-Profiling To Improve Client Experience. The report is to be launched at a special Breakfast Briefing event in Zurich on 7 June. To register for complimentary attendance, please click here.

For Ian Stott, the various methods of assessing clients’ attitudes towards risk all have inherent weaknesses which mean that it is essential that firms draw on a range of methodologies to get a complete picture of the levels of risk that a client is willing – and able – to take on.

Many firms are still upgrading their risk-profiling processes in response to regulatory pressures, with some having to grapple with legacy systems even as they install new technologies. The picture at most firms is then very complex, but a really helpful exercise is to consider what a new entrant to the market could do to make their risk-profiling processes truly “best of breed,” says Stott.

A "three-pronged attack"

In his view, given a “blank piece of paper” a new wealth management firm should be looking to draw on several sources of information and use a real mixture of methodologies when carrying out client risk-profiling. Suitability and Know Your Client information should be taken as “baseline” which is then ameliorated by a “three-pronged attack” of additional assessment. The first of these “prongs” is the traditional risk-profiling questionnaire, which he views as still very important, and the second is behavioural finance or psychometric testing, which he thinks “can produce good outcomes, but not if used in isolation.” But the third and most important element of the mix is holistic questioning, says Stott.

Ongoing discussions and in-depth questioning around all facets of a client’s circumstances are doubtless key to really accurate risk-profiling, commentators on this issue seem to agree. But Stott also made the important point that holistic questioning has one attribute that even the most sophisticated questionnaires or psychometric tests lack: the human touch. As he points out, a person can read facial expressions and other body language and these subtle cues might be far more revealing than a test score on a standardised test. “It’s much easier to spot confusion when a person is sat down opposite you than from a list of ten questions,” he points out.

However, this need for the human touch is very much a double-edged sword, he concedes: the advisor’s skill is crucial and wealth managers need to have a firm grasp on the strengths and weaknesses of their staff in the context of their own business practices. “Not all advisors are made the same; there will be varying levels of skill and some will just be better at the holistic questioning than others,” he says.

"Know thyself"

In his view, what firms need to do is to take their duty of care towards clients extremely seriously, “fully appreciate where the business risks of getting it wrong lie” and build their processes around these considerations. An important part of this could be putting “systems and controls in place around some advisors who are known not to be as emotionally competent as others”, he says. On the other hand, some advisors are very talented at the kind of empathetic “digging” risk-profiling requires and their talents should certainly be used to the full. In fact, Stott can envisage a scenario where an institution could draw on the skills of designated risk-profiling specialists as part of a team banking approach.

For Stott, it is the flexibility of holistic questioning which is key to really accurate risk-profiling – you never know where a conversation may lead and this is often when important details come out. “There isn’t one-size fits all in terms of a perfect scenario. What seems like a minor question with one client might turn out to be major question with another, depending on their level of sophistication and understanding of investments,” he says.

He also echoed a point made by several industry figures speaking to WealthBriefing recently: that it is entirely possible (if not likely) that clients will have multiple risk-profiles for different “pots” of money, such as those for retirement, an additional property, their children’s education and so on. “Clients are constantly chasing different things over different time horizons,” he points out, adding that it would not be “particularly difficult” for wealth managers to treat risk-profiling in silos in line with clients’ various goals.

Evidencing: a major stumbling block

Some firms may be taking an overly simplistic view of risk-profiling in some instances, but in Stott’s view the industry in general is falling down in one key area: evidencing and matching risk-profiling data to the investments recommended.

“The business risk lies first in being able to evidence back to clients that you really do understand their attitude to risk, capacity for loss and tolerance, and then secondly the real challenge is being able to document that,” he says.

One of the trickier parts of risk-profiling is of course distilling what transpires in lengthy holistic conversations into useable documentation, but what is even harder is following through with this information once captured, says Stott.

Capturing and storing information from “fact find” or personal financial assessment documents is one thing, but translating that information into the generation of investment propositions and suitability reports is quite another, he says. In his view, this “feeding through” of information represents the real risk-profiling challenge and suitability reports are where many firms should be focusing their efforts. “Suitability reports are the primary client-facing document… the advice will stand or fall on the basis of what’s contained in that document,” he said.                                                                                 

“Wealth managers have a responsibility to their client’s to ensure that they follow the principles\rules laid down in the Conduct of Business sourcebook (COBS) 9.2.1R which requires a firm to take reasonable steps to ensure that a personal recommendation, or decision to trade, is suitable for its customer. COBS 9.2.2R requires firms, among other things, to take account of a customer’s preferences regarding risk taking and their risk profile and to ensure they are able financially to bear any related investment risks consistent with their investment objectives,” he continued..

“It is still the case that many wealth managers do not yet fully understand the implications of being unable to evidence their understanding of a client’s risk profile… however that might be determined or described.”