Outcomes force focus on risk
CLIENT EXPECTATIONS: BIGGEST CONCERN IS RUNNING OUT OF MONEY
Outcomes-based investing is fast replacing the choose-the-fastesthorse approach to financial advice.
The way financial advice is given in South Africa is changing. This is not just because of regulation like RDR, but because clients and advisors are thinking differently about where the real value of advice lies. Speaking at the Glacier i3 Summit in Stellenbosch last week, the president of Wells Fargo Asset Management, Nicolaas Marais, said this change is happening in many parts of the world. It is a move from recommending products, to discussing and designing outcomes and solutions that meet specific needs.
End in mind
“In the US, 71% of advisers are moving towards delivering outcomes,” said Marais. “They are thinking about liabilities and cash flow needs and working out solutions.”
This, he pointed out, has been the case in the institutional space for years, where consultants start by looking at a pension fund’s liabilities and then design a portfolio that will match those. This thinking is now starting to take hold in the way advisors interact with individual clients as well.
In other words, advisors need to think less about the importance of identifying asset managers based on performance and more about constructing portfolios to deliver individualised outcomes.
“We’re not investment managers,” said Brian Foster, a financial planner and the co-founder of Beyond RDR. “We have to let go of picking funds and telling clients that’s where our value is because I think that’s going to get us into trouble.” This has brought risk to the fore. “In the financial services world we tend to talk about risk in terms of volatility, but what about the risk of not achieving the thing that matters to you most?
“As advisors, we must have the right conversations and define together with the client what they are really worried about. Generally, they don’t care about volatility. What they care about is losing money. They are not risk averse, they are loss averse.”
He added that risk profiling of clients is generally inadequate.
“We try to have a step by step process, but what we are missing is the conversation that needs to take place.”
He noted that there are four elements to a risk profile.
“The first is what is the risk needed to achieve a certain return, and that is a financial construct that has nothing do to with attitude to risk,” Foster pointed out.
“There is risk capacity, which is about the clients’ capacity to withstand the risk given their position. Again, that is not a psychological construct. It is a financial one.”
Where the client’s attitudes become important are in their perception of risk and their risk tolerance. But these alone can’t determine what kind of portfolio they need.
Close encounters
This can only be achieved by melding all of these factors together. Filling in an attitude to risk questionnaire that on its own leads to an asset allocation model does not take into account the realities of the client’s financial situation or market realities.