Recent political events have re-introduced volatility into the markets. This is a good time to review your risk profiling methods to maintain suitability.
Author Andre Correia
Date 24th April 2017
As we have discussed previously, it has been established that risk tolerance is relatively stable, but risk preferences are in flux and are influenced by external factors.
One of the most influential forces in adjusting risk preferences is political uncertainty. Despite a relatively stable reaction to the Brexit vote, the recent announcement of the snap election in the UK, the upcoming final round of the French Presidential election, and the US’ ramp up in foreign policy hostilities, have created some volatility in the financial markets. As more events unfold, markets will continue to react with sharp short-term sell-offs or rallies that will impact the financial outlook of retail investors. These factors, and other market moving events, are going to affect the individual risk preferences. Understanding how those preference shift over time will be a crucial element of ensuring suitability of financial advice.
If you are concerned with ensuring suitability of advice, we have some suggestions to help you better understand the needs and preferences of retail investors.
Regular recalibration of risk profiling instruments
Each of our clients has a unique and specific customer base with demographic characteristics that differentiate them. This means that using a one-size fits all approach to risk profiling would be innapropriate. Indeed Oxford Risk calibrates all its instruments to account for your client’s demographics and thus ensure the appropriateness in the risk rating results. With regards to risk preferences, which are likely to shift over the years, the general appetite for risk within the market will have an impact on what investment solutions will be appropriate at any one time. As such, regularly recalibrating all risk profiling instruments, as well as the suitability analysis, is a crucial requirement to ensure their continued accuracy.
Running suitability assessments regularly
It is considered best practice to run a suitability assessment every time your investor wishes to invest. Their preference for risk will be affected by many factors, including the recent political events, recent investment experience, the ability to withstand the latitude of consequences an investment will have, and should be accounted for ahead of every investment and/or yearly review. Even if the investor feels that their risk preferences have not changed, reviewing their tolerance and financial requirements could show that there is a different more suitable solution for them.
Furthermore, an investor’s ability to bear loss can also change from goal to goal, quite dramatically, which in turn will affect which investment is suitable for them. The purpose of regular testing is to avoid assumption, and this best practice is particularly relevant with retail investors as they may not have the knowledge or experience to consider all relevant factors when investing. This is also going to be a requirement of MiFID II: an investment firm that offers advice or portfolio management will need to carry out suitability checks on behalf of the investor for each transaction.
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