April 2017

Risk, Risk Profiling and Risk Tolerance.

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Mapping of the Momentum UK Managed Portfolio Range

FinaMetrica Pty Ltd - Monday, 24 April 2017

FinaMetrica is delighted to announce that the Momentum UK Managed Portfolio range is now mapped to the FinaMetrica risk tolerance scores.
 

The Momentum Managed Portfolios are an outcomes-based solution designed to give investors access to discretionary investment strategies. These solutions are structured to provide a sophisticated investment offering that aims to perform strongly in an array of market conditions and is very competitively priced. This Managed range consists of six Managed Portfolios designed to cater for a wide range of risk and return appetites. All the Portfolios utilise our investment desk’s macroeconomic views, asset allocation framework and contain investment instruments carefully selected by the team from leading global financial institutions.

The Portfolios target inflation plus returns over four or more years. They are broadly diversified investing in a range of equities, fixed income, cash, property and alternative strategies. The Portfolios’ asset allocations are actively managed and reflect Momentum’s views on asset classes, regions and currency. These can be implemented using either active or passive strategies. The Portfolios are also rebalanced on a regular basis to ensure that the asset allocations adhere to the original risk profiles.
 

For more information, visit: https://www.momentum.co.uk/uk-advisers/
 

Posted: 24/04/2017 10:39:38 AM by FinaMetrica Pty Ltd | with 0 comments


Risk Tolerance Assessment Misconceptions

FinaMetrica Pty Ltd - Friday, 21 April 2017

We recently had a request from a long term subscriber John Reilly, the Managing Director of Good Will Financial Services in Bristol to assist in his ongoing due diligence of FinaMetrica's risk profiling integrity..

"Through normal due diligence research, I read this article with an open mind. It became strikingly obvious, when I read a couple of their examples of ‘poor practice’, that they were talking about FinaMetrica (without naming the innocent!). I would be grateful if could respond to these ‘criticisms’ and the other aspects they raise."

We responded:

We see articles like this pop up now and then and while well intended they tend to confuse the subject matter further. Most of the concerns stem from a poor understanding of what risk tolerance is and how it fits into the risk profiling process and psychometric testing. We’ve provided two examples below.
 

The article references the FCA (FSA), paper in 2011. We reviewed the FSA paper and wrote to the FSA to clarify some of the misconceptions around risk tolerance assessment and psychometrics. You can read our comments here. We had no response from the FSA and the guidance was finalised a few months later with no meaningful changes.
 

Our view then and remains now that the FSA paper was a good start to improving risk profiling but set a very low standard. We reviewed all of their comments and decided that we could only reduce the effectiveness of our test if we followed their 'advice'. Hence we’ve made no changes on our end.

For example 1:

Extract from http://adviserbusinessreview.com/risk-profiling-tools-remain-flawed-need-new-approach :

Compared to others, how much of a risk taker are you?This question requires the client not only to make a judgement about themselves based on undefined and subjective multiple choiceanswers but also to make a judgement about others. It is an impossible question!
 

Roszkowski (1992) commented that “another ostensibly straight forward approach to assessing risk tolerance involves asking the client to classify himself or herself with respect to the amount of risk that he or she can tolerance”. It should never be the sole basis for determining a client's risk tolerance, but along with other items, a global self-rating adds to the assessment process because it captures elements that the other items may not be able to tap.
 

Furthermore, the research literature shows that people can to some degree estimate their own risk tolerance among others. Grable et al (2006) conclude: "Self-assessed financial risk tolerance was found to be a statistically significant predictor of general financial risk tolerance, cash holdings, and equity holdings, both by itself and when analysed using control variables. The amount of variance explained by self-assessed risk tolerance, by itself, ranged from 2% for cash holdings to 27% for general risk tolerance." In a study using The American College's Survey of Financial Risk Tolerance, Grable and Roszkowski also found that the correlation between self-assessed risk tolerance and risk tolerance as assessed by the other items in the test to be .41.
 

The LSE analysis of FinaMetrica data shows that the self-rating questions scored very well. They have high correlations with the other items and load strongly on the risk tolerance factor and Doehman (2005) paper provided strong evidence regarding how predictive a global self-assessment of risk tolerance can be.
 

For example 2:
 

Extract from http://adviserbusinessreview.com/risk-profiling-tools-remain-flawed-need-new-approach :

Is it more important to you that your money keeps its buying power or that you dont suffer a loss?This question expects the client to compare two non-opposing factors.Maintaining buying power is not the oppositeof not suffering a loss. It is like asking, Do you prefer vegetables or holidays?
 

The question as presented is poorly worded and requires the contextual explanation before it.
 

We agree with the article that risk profiling is the start of a conversation, a discussion piece; however, the measurement of risk tolerance should be done using a proven scientific discipline like psychometrics.
 

Advisers are responsible for the processes and tools used in formulating advice. Advisers must satisfy themselves that, at a minimum, any tool used is both fit for purpose and true to label. Our Due Diligence Checklist is designed to help you conduct due diligence on any risk tolerance test in the market, including ours, we’ve completed one for FinaMetrica at the end of the checklist for you.
 

Reference
Roszkowski, M. J. How to assess a client’s financial risk tolerance: The basics. Personal financial risk tolerance. Bryn Mawr, PA: The American College, (1992) pages 6 to 7.

Grable, J., Roszkowski, M., Joo, S., O’Neill, B., & Lytton, R. How Well Do Individuals Assess Their Own Risk Tolerance? An Empirical Investigation. Consumer Interests Annual, (American Council on Consumer Interests), (2006), 52, 229

Dohmen, Thomas J., et al. "Individual risk attitudes: New evidence from a large, representative, experimentally-validated survey." (2005).

 

Posted: 21/04/2017 3:51:05 PM by FinaMetrica Pty Ltd | with 0 comments