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The use of Risk Profiling Tools

The risk profiling tools used by advisers have previously been described as a “ticking time-bomb”. These tools have not been scrutinised for years, and now there are fresh concerns over the wildly different asset allocations that different tools produce.

Determining what risk a client can take with their money – and then suggesting an appropriate investment plan to meet these needs – is a central part of the advice process. So, there is bound to be keen interest in a new report from former FCA regulator Rory Percival, particularly as it is the first review of the sector since the then regulator the FSA’s damning report in 2011, which found that nine out of 11 risk profiling tools “had weaknesses which could, in certain circumstances, lead to flawed outputs”. This has led to questions about whether these profiling tools were really fit for purpose.

The finalised guidance from this report is available here.

  • What happened?

    The report attempts to answer this question by taking an in-depth look at six of the biggest risk profiling tools used by advisers. The six under scrutiny are A2Risk, EValue, Dynamic Planner, FinaMetrica, Morningstar and Oxford Risk. These companies also provide risk profiling services through other third-party brands, for example Iress and Defaqto. Although Percival found that risk profiling tools had improved significantly since the 2011 FSA review, and are now far more integrated within the advice process, not one of these tools gets a completely clean bill of health. He notes all these tools “to a greater or lesser extent involve limitations”.

    The report uses a red, amber, and green system to review each risk profiling tool against 11 key criteria, based on the parameters set out in the previous FSA review. For advisers, this shows certain risk profiling tools have far more concerns flagged than others.

    Two of the risk profiling tools come out ahead of the others: Dynamic Planner and FinaMetrica get just two amber flags and all other aspects of the risk profiling process are rated green. EValue has three amber flags. Morningstar gets one amber flag and one red. Oxford Risk gets two amber flags and one red while A2Risk gets five amber scores and one red.

    With both Oxford Risk and A2Risk, the red flag is for the risk descriptions used by these tools, which Percival claims are not always clear. For example, when A2Risk outlines its “cautious” category, Percival says it isn’t clear whether this covers no risk clients, very low risk clients or both.

    Meanwhile, Morningstar gets a red flag because its risk profiling tool does not generate a “not suitable for investing” category at the outset.

    Percival points out this is not highlighted in the information given to advisers, but it is important that advisers using this system identify such clients at the outset before proceeding with this tool. This was an issue that tripped up most risk profilers. With the exception of Dynamic Planner, they all received an amber warning on this particular test.

    Many of the other amber flags concern the way questions might be open to interpretation (particularly in relation to ‘middle’ answers), or whether a question, incorrectly answered, has the scope to tip the client into the next risk category. There were also concerns raised about whether these tools could potentially combine a client’s risk profile with their capacity for loss and knowledge and experience of investing. Percival points out that, under regulatory guidance, these separate aspects should not be combined into a single score.

    Some of the most significant findings of this report concern asset allocation. Percival says he has serious concerns about the way some of these risk profiling tools produce very different results when it comes to asset allocation.

    Not all the tools offer this additional process. Neither Oxford Risk nor A2Risk, for example, include asset allocation as part of their risk descriptions. The report looked at different hypothetical situations to see what asset allocations would be recommended for a cautious, medium or more adventurous investor. The results can differ widely. For example, an adviser using the EValue tool could end up putting a “cautious” investor into a portfolio where 50 % of the portfolio is invested in equities and property. With FinaMetrica just 22 % of the portfolio would be in such assets.

  • How Thistle can help you?

    Thistle will continue to keep this area under review and will issue further updates as the situation develops. For more information, email or call 0207 436 0630.