Mapping is the means of matching investors and investments, determining the right level of investment risk for a given investor’s risk profile.
A risk profile puts investors on a scale describing how much risk they are willing and able to take compared to other investors. However, the fact that investor A has a higher risk profile than investor B doesn't tell you exactly how risky their portfolios should be. Oxford Risk's investment solution mapping process is unique in the suitability-assessment space, applying a robust academic methodology to align investors with investments.
An effective investment solution mapping process should:
Account for both risk tolerance and risk capacity: an investor comfortable with any level of long-term risk would presumably take the highest level of risk they were able to (as defined by their risk capacity), but this is not necessarily the riskiest portfolio in front of them.
Define suitable risk bands: mathematically modelling the range of risk–return trade-offs that are acceptable to investors with different risk profiles makes it straightforward to select the most suitable portfolio.
Limit risk exposure for investors with certain behavioural traits: investors with high risk capacity are typically able to comfortably take on a level of risk above their risk tolerance; however, investors with low composure are made more anxious by such increases in their risk profile.
Ongoing, accurate mapping between investor risk profiles and investment risk levels can ensure that suitability is maintained even as market conditions require portfolio changes.
Mapping a risk profile to a suitable level of risk is determined by the investor’s preferences for trading off risk and reward. If poor market conditions mean the expected returns that can be achieved from a certain risk level are reduced, the rational response is to take less risk, as the investor will expect to get less back for each unit of risk they take.
If the mapping between risk profiles and investment risk is static, the investor will be taking a fixed amount of risk even when market conditions make it irrational to do so.
Accurate mapping of ready-made portfolio solutions can also help advisers, investment managers and platforms to promote the most-suitable solutions, rather than best-guessing it.
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