Risk profiling update:

The Synaptic risk profiler from A2Risk has just been updated

It is impossible to imagine modern advice and financial planning without a competent risk framework. The Synaptic questionnaire is from A2Risk, the most widely used ATRQ in the UK. Its popularity perhaps reflects the strength of the academic rigour behind the question set, and the reliability it has demonstrated across a variety of applications.

Many propositions reference the Moody's risk metrics, but Synaptic gives advisers full access to the stochastic projections, which can be used to build investment strategies using the asset allocations as well as recommend and review portfolios.

The questionnaire is used by Royal London and Vanguard amongst others, but much of its prestige comes from its alignment with Moody's Analytics (formerly Barrie + Hibbert), the leading investment risk model (by far).

For many years organisations at an institutional level have relied on the Moody's simulation-based (stochastic) model, but now advisers can fully access Moody's expertise through Synaptic. Many propositions reference the Moody's risk metrics, but Synaptic gives advisers full access to the stochastic projections, which can be used to build investment strategies using the asset allocations as well as recommend and review portfolios. All this is possible with automated access and very low expense.

In referencing the 'investment strategy', the truth that a chain is only as strong as its weakest link fully applies. The investment outcomes of clients are simply too important to risk making mistakes, or not achieving consistently at the highest possible level. All elements must be aligned and functioning properly for the system to work.

Our colleagues at RSMR recently wrote about Modern Portfolio Theory and this elicited some responses around the contribution made by Harry Markovitch around his work on modern portfolio theory. I watched a recent video for GuidedChoice (US) of Markovitch reflecting on the contribution that advisers are able to make to their clients' financial well-being. Having the structure, discipline and patience to reap the rewards of the markets is no small matter. He discusses the central truth of investment, that 'in the long run', reaching for greater gains will by necessity result in higher volatility 'in the short run', and that embracing the correct balance of risk and return is what will ensure that the client doesn't 'chicken out of the program' when the volatility kicks in. (His words!).

Every year there is a slew of articles about 'serious concerns' about risk profiling. Do any of the criticisms really stick when it is done properly? No. The adviser remains firmly in control and these tools are able to enhance his or her expertise.

We know from following the ombudsman's rulings that advisers who end up in dispute and have not employed a robust process to evaluate risk and return lose every time and rightly so. It is a thing of great beauty that such consistency and success is achievable by marrying a few simple questions asset allocations.

Many individual items contribute to overall success. Investment platforms, providers, cheaper share classes, star managers, streamlined businesses, automated engagement, qualifications, tax optimisation can all be part of the mix, but in investment terms, all are nothing without the solid foundation of competent risk profiling, an adviser's expert assessment of 'capacity for loss' and alignment to investments whose profiles are effectively assessed for risk and return.

Every year there is a slew of articles about 'serious concerns' about risk profiling. Do any of the criticisms really stick when it is done properly? No. The adviser remains firmly in control and these tools are able to enhance his or her expertise. A2Risk and Moody's are constantly examining their assumptions, conducting new research, re-running their models and up-dating their customers – how can you replicate that?

Rory Percival's report on risk-profiling last year had an enormous influence, prompting many firms to try and better understand (and account for) the role of risk profiling in their businesses. Appreciation for the leading risk profiling tools increased, and progress was certainly made in helping firms move towards their MiFID II requirements of knowing their tools (and their limitations).

A slightly less valuable result of the report was the inference that risk profiling should conform to an industry standard. For example in his comments about the '50 client' Rory wrote 'in theory, given that the risk profiling tools generally map clients onto the normal distribution of clients in the UK, the '50 client' should score 50 with all the tools'.

Sounds reasonable but it only tends to conform if the same 'population sample' is used in research across the tools. Research into the general population (risk averse) will calibrate differently to research into the population of wealthier income earners (clients). Following these comments, A2Risk has seen the need to shift its methodology around population sample, and in doing so losing a sensible 'anchor' into the general population, and thus, arguably, losing some perspective. Not a great deal perhaps, but I think we should all resist pressure to look and act the same, for conformity's sake – that's where mono-culture develops and systemic risk grows.

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In the update, there are minor changes around the identification of 'very cautious investors' and the language in some of the questions (for example volatility is out, to be replaced by more everyday language). With these minor changes enacted, the questionnaire feels more user friendly. Many advisers felt that the calibration of the risk categories seemed 'too high' and will be happier now, and the expansion of the more Cautious bands should help secure a more comfortable fit across the range.

Advice from A2Risk on adopting the new questionnaire is as follows:

'Customers who have completed the previous version of the ATRQ can complete the new version when their portfolio is reviewed. There may be minor changes in the score at that point due to the updating of the logarithm. In this case, the change can be discussed with the client and a final category agreed. For most customers, there will be no change, unless their own answers to the statements have changed'.

Any adviser can access the A2R questionnaire as part of the Synaptic Suite free of charge. Call 0800 783 4477 for access.