Paul Resnik: Why I disagree there are 'no standout risk tools'

Suitability will be high up the agenda over the coming months as the regulator prepares to publish its latest findings on the subject.

The Assessing Suitability Review will, alongside the Financial Conduct Authority's studies of both the retail distribution review and financial advice market review, ensure that the matter of risk and how advisers measure and discuss it remains a big discussion point in our industry.

One of the reasons for that was evident in a recent Professional Adviser and Multi-Asset Review article - Battling regulation: Is compliance pushing clients to lower risk investments? - that asked how advisers broach the topic of risk with clients.

The debate offered plenty that we could agree with, such as the observation from one Chartered financial planner that his clients only fill out risk questionnaires once it has been clarified that they would benefit from advice. This approach encourages dialogue before jumping to the conclusion that investing is a suitable recommendation.

The article also asked whether advisers should be educating clients to take more risk in order to reach their objectives, or if they should promote a more cautious approach. The answer to that is clear - they should educate clients to take an investment approach consistent with their risk tolerance and which they feel comfortable with.

Getting investment recommendations right requires a blend of art and science - the latter being the tools used and the former referring to the ability of the adviser to use them effectively, by working with clients to ensure they have a firm understanding of their needs.

Most importantly, there needs to be proper informed consent through a valid and reliable assessment of risk.

Which is where the industry currently falls short. As the article pointed out, while risk questionnaires are essential in ascertaining an investor's risk tolerance, there is some confusion out there as to the best approach to this.

There remains a lack of clarity as to what is considered ‘good' when it comes to risk profiling tools, and what is not so good. There are lots of personal opinions creating a lot of white noise, but no proven assessment that will steer advisers away from the dangerously flawed quick-and-dirty tools that are out there.

'Little or no validity'

Rory Percival did say in the article that there are "no real standout risk profiling tools". However he quickly clarified elsewhere this was a reflection of market share rather than effectiveness, adding that when it comes to the latter the two that stand out are FinaMetrica and Oxford Risk.

There are clearly good tools that are academically and scientifically proven to assess risk tolerance and then there are others that have little or no validity. Until there is an independent and academic assessment that highlights the dangers of using unproven risk tolerance tools, advisers and clients will remain in the dark.

The approaches that advisers currently use sit on a broad spectrum. At one end are the ‘gambles' questionnaires that some software providers are peddling, and which drive the risk assessment systems used by a number of major investment propositions.

These are concerned with how clients feel about potential gains and losses, rather than on their actual risk tolerance. There are several significant flaws in this approach, not least that there is little consistency, the probabilities are inherently complex and they do not provide a full picture of what constitutes risk tolerance.

At the other end of the spectrum is a more scientific approach in which the test and the methodology are subject to extensive independent validation and due diligence by industry experts and academics.

The guide to risk profiling tools that Rory produced in 2017 is a directory of some of the tools on offer that state some features and benefits and sets out personal opinions of the author. It certainly is not an accepted industry study that will educate users in any useful way when it comes to assessing the actual validity of the different risk profiling tools available. And, to be fair, the guide made it clear from the outset that it was not backed by any scientific or academic assessment.

So, nearly a decade after the FCA's predecessor the FSA's 2011 assessment of risk tools, there are still no rigorously tested standards for risk tools that enable advisers to make a fully informed comparison of the various options available. While the regulator found at the time that many tools fell short of ‘acceptable' standards, it was unable, for legal reasons, to disclose which tools passed and which didn't.

As it stands, advisers will often use the most "popular" tools, partly because, as Rory commented, "there aren't many tools that have got a better reputation than others that means everybody uses them". We would argue that is down to the fact there is no accepted measurement of good and bad practices for risk profiling tools.

We believe advisers (and their clients) deserve and would benefit from an independent academic study that compares and contrasts the methodology, validity and reliability of the various tools available in a meaningful way.

Paul Resnik is co-founder FinaMetrica, part of Plan Plus Global

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