As more and more advisers turn to outsourcing, Rob Gleeson, head of research at FE, explains the importance of keeping client risk profiling in-house.
There is a lot of talk about increasing financial education in schools to help people better manage their finances as adults, but it is likely to be to little effect unless it includes a thorough examination of the notion of risk.
Lesson one on day one of the course should start by looking at how the financial industry measures risk and how far that is from the ordinary person’s intuitive grasp of the concept. There is a danger of miscommunication on the matter and one of the crucial jobs for advisers right now is to help make sure this does not happen.
Because of the way the industry is going, investors could end up stranded as squeezed advisers increasingly rely on crude ways of looking at risk that do not take into consideration their personal circumstances.
Should we be talking about volatility with clients?
The outcome of all this would be increased distrust of the financial services industry and an unwillingness to invest. This could obstruct the government’s aims to encourage saving, causing havoc for the UK’s fiscal future, given the huge retirement costs faced by our aging population.
Volatility vs risk
Industry shorthand uses volatility as a proxy for risk and this feeds into the literature and the thinking behind risk profiling. On a very basic level, volatility is clearly a long way from what the average investor imagines risk to be.
Volatility just measures the dispersion of returns, without taking into account their direction.
Some funds have very low volatility but have returned less than inflation in recent years – in some cases, they have even lost money. While they are considered low risk by most industry yardsticks, the average investor would be unlikely to agree.
Consider the CF Miton Special Situations portfolio, managed by Martin Gray and James Sullivan. This is a fund that FE rates highly and which made its name by making money in 2008 when the markets sold off.
Although it has had a growth spurt in the past few months, thanks to exposure to Japan and the dollar, it has still made slightly less than CPI over the past three years. During that time, it had an annualised volatility of just over 4%, which would qualify it as low risk by industry standards.
Its low returns are a consequence of the fact the managers have positioned themselves for a return of market volatility and asset price falls.
This article continues…
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