Risk profiles are risky, advisers admit

RESEARCH AMONG FINANCIAL PLANNERS CONFIRMS THAT QUESTIONNAIRES ARE FUNDAMENTALLY FLAWED You can receive inappropriate financial advice if the advice is based on a risk profile that was determined using a flawed questionnaire. Laura du Preez reports

All the major providers of financial products still require your financial adviser to complete an investment risk questionnaire before they will accept investment applications from their clients, despite the fact that these questionnaires are “fundamentally flawed”, the annual conference of the Financial Planning Institute (FPI) heard this week.

Anton Swanepoel, the managing director of Amity Wealth who has been in leadership roles in both the FPI and the Financial Intermediaries Association of Southern Africa (FIA), told the conference there is overwhelming evidence both locally and internationally that risk-profile questionnaires are problematic, yet advisers are unable to place investments with companies or investment platforms unless they have used them.

A risk-profile questionnaire is typically used to determine the extent to which you should be exposed to investment risk, on a spectrum from conservative (little to no risk) to aggressive (a high degree of risk).

You might receive inappropriate advice if the advice is based on a risk profile that was determined using a flawed questionnaire.

The general code of conduct that forms part of the Financial Advisory and Intermediary Services (FAIS) Act obliges financial advisers to advise you on products that are appropriate to your risk profile and your financial needs.

If you are given inappropriate investment advice, you can complain to the Ombud for Financial Services Providers. In many cases heard by the ombud, advisers have been held liable for the losses suffered as a result of advice that was inappropriate for the investor, and the ombud has ordered them to compensate their clients.

Swanepoel surveyed nearly 550 South African financial advisers who are members of the FPI and FIA, and 85 percent of them reported that, in their view, the riskprofile questionnaires they use are inadequate in assisting them to provide appropriate advice.

Swanepoel says the first major flaw with risk-profile questionnaires is that they do not take into account how much investment risk investors need to take in order to reach their financial goals. This is despite the fact that the FAIS code of conduct specifically requires an adviser to understand your investment needs and objectives.

FAIS OMBUD’S VIEW

Swanepoel says Noluntu Bam, the Ombud for Financial Services Providers, said in her 2012 annual report that in many of the cases that came before her she found a disconnection between a complainant’s tolerance for risk, as assessed by his or her answers to a risk-profile questionnaire, and the complainant’s financial circumstances and ability to withstand losses (capacity for risk). Bam found the mismatch to be particularly prevalent in cases where advisers had recommended that pensioners invest in high-risk unlisted property syndication schemes, even though, because of their limited means, they could not afford any investment losses.

Bam said the answers to riskprofile questionnaires can be interpreted in several ways, and the questions are not always specific or relevant to the investment at hand. Risk must be disclosed in “clear, unambiguous language”, she said.

Swanepoel says investors should understand the range of returns they can expect from their investments and the losses their investments might incur.

In the same year that Bam’s report highlighted the shortcomings of risk-profile questionnaires, the regulator of financial services in the United Kingdom, the Financial Services Authority (FSA), released the findings of a survey that found that nine out of the 11 Top financial planners have the following to say about your risk profile:

Peter Hewett, the managing director of Hewett Wealth and the 2014 Financial Planner of the Year, says you need:

A clear understanding of what investment volatility is;

A clear understanding of what the potential returns of your investment are; and

Examples of what your investment losses could be over various time periods.

An investor’s risk profile should take into account that market performance can affect how he or she feels about investment risk.

During bear markets, investors who said they wanted to invest aggressively become “pussy cats”, but when markets are roaring ahead, investors blame advisers for not having invested more aggressively, Hewett says.

He says the financial services industry needs to define investment risk-profile questionnaires it scrutinised were fundamentally flawed.

Despite these findings, the financial services industry has done nothing about risk-profile questionnaires, Swanepoel says.

Since the FSA’s survey, research in Canada has found that 83.3 percent of risk-profile questionnaires are “not fit for purpose”.

The independent company that completed the research for the Canadian Investor Advisory Panel found that the questionnaires had too few questions, poorly worded or confusing questions, poor or arbitrary scoring models, or the scoring merged multiple factors, according to a paper written by Swanepoel.

His paper is being scrutinised by the FAIS supervisory department of the Financial Services Board (FSB), Swanepoel told the FPI conference.

He urged his peers in the FPI who hold the Certified Financial Planner accreditation – one of the highest qualifications an adviser can obtain – to do something about risk-profile questionnaires before the FSB introduces regulation on risk profiles. discuss, Norval Hart says.

She also recommends that you and your adviser discuss your returns and investment risk at each annual review, at which time your adviser should remind you why you are invested in a particular way and of the probability of negative returns.

Wouter Fourie, a financial planner with Ascor Independent Wealth Managers and the 2015 Financial Planner of the Year, says he does not believe that people with the same amount of money to invest but totally different objectives should have the same investments, but this is what risk-profiling achieves.

His advice process involves 22 steps intended to ensure you make an informed decision, he says.

His process involves showing you a cash-flow plan for your investments and ensuring that you understand the investment you are making. You won’t trust the advice you have been given if you do not understand it, he says.