Risk Profiling and Asset Allocation

The Botha Determination by the FAIS Ombud certainly touched on a sensitive area, never covered before in the same detail as in this case.

The Ombud found that the clients suffered loss as a result of proper care and diligence when considering the clients’ risk profiles, and the subsequent placing of funds in unsuitable portfolios.

The areas of risk profiling and asset allocation will always contain an element of subjectivity and controversy, and even more so when hindsight comes into play.

A very knowledgeable and highly experienced broker responded to the determination as follows:

I agree with the Ombud as, in this case, it is clear that the IFA effected a strategy that was markedly at variance to the client’s objective and subjective profiles. The Ombud was also reasonable in determining the quantum of damages.

Notwithstanding that this is a fair determination; it does raise concerns, namely

  • Does this open the floodgates to hindsight review of fund selection? The boundary between an actionable selection and one that is not actionable is unclear. The net result is that fear of hindsight fund selection review will push IFAs to becoming more conservative. This would be to the prejudice of many clients. Most retirees’ portfolios that I come across are too conservative, in that with inflation and good mortality, they are guaranteed a life of eventual penury. This may be the major unintended consequence of this ruling; for IFAs may rebalance to be more conservative to protect themselves from regulatory review rather than remaining true to the clients’ objectives and needs. Thus, fear of hindsight review may end up being to the detriment of many clients.
  • Alternatively, (and mark my words, this scenario will come), when the market really runs, a client will say, I should have been in a more aggressive portfolio and the reverse decision will be granted.
  • Blatantly inappropriate advice, such as in this determination, is easy to assess, but as you come closer to the margin, we enter into a minefield. The reason is that with the clarity of hindsight, it makes it so easy to allege inappropriate advice. The whole assessment process is subjectively different at the time of advice and the time of complaint when you are armed with hindsight knowledge.
  • Reliance on Risk Profiling Tools & RDR: I use a standard tool purely for compliance purposes. With respect to the regulators, it adds little value other than fulfilling my compliance need. I fine tune this with a lengthy discussion on subjective and objective risks. A major risk profiling exercise is, however, expensive. Roll on RDR when I hope we can say, “Sir, I want to conduct a detailed Risk profile—the charge will be R1000. Alternatively I can use this abbreviated risk profile form but it will not be as accurate.” I cannot see many clients paying, but I suspect in terms of FAIS, the Regulators will still expect a quality risk assessment from the IFA. I hope the regulators, in the RDR, factor in the many costs of advice, such as, for example, objective risk profiling tools which can be quite expensive.
  • My major concern; however, is that this ties in with the large life office trend to push clients into ‘risk profiled solution funds’. This is the most profitable outcome for the life offices and they will aggressively use this determination to drive this trend. IFAs are feeling threatened and life offices will be arguing—“complete our risk profile questionnaire, place all the client’s money in the indicated fund and we will protect you from the Ombud and the client”. In addition, they are implying that you do not have to apply your mind again to the portfolio unless there is a change in client circumstances. The life offices will send clients a standard quarterly report and you, Mr IFA, have to do nothing other than bank your trail fee.
  • In my personal capacity, I would rather manage my own portfolio than use a solution fund. It carries more risk, which I balance against the potential higher return. If I choose to do this for family and myself, surely I am being dishonourable if I do not do the same for my clients? That all said, regulation, compliance risk and large life office market interventions might force me in that direction. This is a major unintended consequence flowing from the regulator’s well-intentioned and correct determination.

The regulator has to make determinations when blatantly inappropriate advice is brought to their attention, but in this area, they need to be aware of the unintended consequences. The solutions may not be easy, but to ignore the issues will be to the detriment of pensioners whilst the life offices see their coffers swell.

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