|Are you uncomfortable with the way your firm’s advisers match investments to clients’ needs? If you are discomfited, you are not alone.|
Regulators, and by default advisers, around the world are paying increasing attention to the logic and rationale used to reach investment recommendations.
FinaMetrica has historically worked with high-end, predominantly independent financial advisers, mainly in the US, the UK and Australia. Many share a common investment suitability process. In the UK it’s largely consistent with the Financial Services Authorities Guidance on suitability and in Australia it’s consistent with the Financial Ombudsman Service’s approach to complaints assessment.
This is my understanding (and simplification) of their practice. Pleasingly, it is also largely consistent with, and perhaps a little more intuitive then, the processes we outline in our education materials. See our QuickStart Guide, page 14. I have broken the process into five stages. To make the whole thing a little easier to remember I have developed the acronym ADAPT. Not only does this take something from the imperative for having a business model that meets the new needs of both clients and regulators, it’s also relatively easy to remember.
Awareness of risk tolerance. This is simply asking the client to read and think about their risk tolerance report, generally before the first meeting with their adviser. If client has a life partner, it’s also suggesting that they sit together and talk through the similarities and any differences in their reports which might reflect how they manage money and make financial decisions in their lives. This means they come to the first meeting with an understanding of their risk tolerance compared to each other and the general population.
Discussion of the risk tolerance report. The adviser talks through the report with client(s), specifically exploring individual differences and differences between any partners. Many advisors have told me that this is the time when client and adviser rapport is first established. It’s the “Aha moment” when an in-depth client-adviser relationship is born. The report forms the basis of the client’s instructions to the adviser about the level of risk they would prefer to take.
Asset allocation link to the agreed risk score. The adviser converts the client’s instructions to an asset allocation which in turn can be linked to a portfolio that can be tested against the client’s goals. FinaMetrica provides a detailed methodology to link risk scores to portfolios, see Linking Spreadsheet. Many advisers use this as the starting point for a collaborative/ iterative planning conversation that takes into account prioritisation of client’s needs and life style choices. The link is the single most often-raised issue in my talks with advisers and others in the supply chain.
Project forward the range of performances of that asset allocation/portfolio to show client(s) the likelihood of their liabilities being met as they fall due. It’s possible that the portfolio consistent with risk tolerance is different from the portfolio required to meet the client’s needs. It’s also possible that the client has a risk capacity that is less than consistent with that portfolio. The plan resolved also needs to take into account the client’s alternative spending, working and investing capabilities.
Test client(s) understands the risks. Explaining risk is not easy. The statistical information that advisors work with – mean, standard deviation, confidence intervals, likelihood of a negative return and so on, is not readily digestible by the typical client and is unlikely to give them a meaningful understanding of what lies ahead. Clients need to have a feel for the patterns of portfolio performance that can be expected over time. Here, the past is a great ‘tool’ to illustrate ups, downs and outcomes. Advisers can show how the recommended portfolio has performed in the past. The goal here is to frame investment expectations such that clients are not surprised by their portfolio’s future returns and volatilities, particularly by extreme events, see Risk and Return Guide.
ADAPT is a critical component of the shift from product-centric sales processes to one where advice leading to a client’s informed consent is the new norm. Consequently, most players in the chain, other than a small number of already compliant IFAs, are enjoying an unprecedented opportunity to manage their own change.
I am very keen to receive comments on ADAPT. To kick off the conversation:
- What are its weaknesses?
- What needs to be clarified?
- What alternative approaches to it are there?
- How best to communicate it.
- Who else in the supply chain should we be talking with?