Risk profile
Why Risk profiling and not a risk questionnaire?
Research shows that investors frequently construct the design of their investment portfolio on past experiences and their own interpretation (or experience) of risk. Previously experienced volatility and past performance too significantly contribute to the nomination of the portfolio design.
Research also shows that many financial advisors prefer to agree with a client’s interpretation and nomination of a portfolio design, rather than differing with them on this important subject. The actual client requirements and subsequent portfolio construction are often not empirically tested or processed on an independent basis.
Frequently a risk questionnaire is completed with a score or rating applied to each answer. The answers range from a conservative to an aggressive option, with many of the questions being based on the client’s perception of risk, and not on quantitative, researched, or clinical analysis.
Whilst it is important for an advisor to be aware of a client’s perceptions and expectations, it is the advisor’s role to guide the investor – based on fact, proven research, and quantitative investment strategy and philosophy. It is very often the case with a poorly designed risk questionnaire, that clients are invested into a portfolio which may not achieve any of their actual requirements.
A good example of this is a client stating that they require an accumulated medium to high long-term investment return and stating as much on the risk questionnaire. What the risk questionnaire does not ask (in this hypothetical example) is that the investor only has (say) two years to invest the money.
The scoring on the risk questionnaire is (say) 10 points for the required return and only (say) 1 point for the (short) duration of two years. The resultant calculation then determines that the client is a “medium risk” investor with the predetermined portfolio allocated to this risk profiled investor having a lower expected return over a longer time horizon than they (actually) have the time to achieve this.
If this portfolio was then used, the client will likely be disappointed with the more conservative returns achieved, which will not meet their expectations or their requirement for the capital in the practical duration of two years. This inappropriate allocation would not allow enough time for the portfolio managers to achieve the portfolio goals. In effect, the client (in this example) would be let down on both accounts of appropriate risk and determined duration.
In GTC’s opinion, many risk questionnaires create unwanted and unintended ambiguity and out-and-out errors of judgement. GTC therefore does things differently.
We gather relevant required data, ensuring that we have a good understanding of a clients’ investment requirements. Our risk profiling process avoids client and advisor perception and predetermined outcomes. We are able to advise a client, based on empirical data and exhaustive statistical information as to how best achieve the required investment objectives taking into account investment risk, inflation, prescribed time horizons and accurate assessments of influencing risk.
Where an investor feels subjectively uncomfortable with a recommended portfolio risk, we can quantitatively illustrate the actual parameters and consequences, together with alternative ways of achieving the required goal.
