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ProQuest is not a 'portfolio-picker' questionnaire!

In recent years it has become commonplace for advisers to deal with determining asset allocations in a single step by way of scored questionnaires, variously called 'Risk Profilers' or 'Investor Profilers'. These combine the client’s answers to (usually) less than ten questions about their age, experience, attitudes to risk, time horizon and the like, to select one of a range of "profiles" each of which is associated with an asset allocation.

In addition to having been developed without regard to the technical disciplines of test construction, these 'portfolio-pickers' suffer from the following conceptual flaws:

• because of the inclusion of situational questions, risk tolerance per se is not assessed (often despite claims to the contrary),

• the return required to meet the client’s goals is not assessed,

• the existence of any mismatch between risk tolerance and the risk inherent in the return required is not identified so that neither the client nor adviser is in a position to know whether the asset allocation chosen will meet the client’s goals or is within the client’s risk tolerance, and 
  
• if there is a mismatch, the scoring algorithm resolves it by a compromise based on the test designer’s view of the values the client would bring to such a decision (rather than
  the client’s actual values) and without considering the alternatives.

Portfolio-pickers dis-empower both adviser and client. It would be difficult to argue that a client gave informed consent to the implementation of an asset allocation chosen by a portfolio-picker. And it certainly could not be said that the adviser had made an assessment of the client’s risk tolerance.

Portfolio-pickers were never an ideal solution for what we readily acknowledge is a difficult set of problems. However, now that scientific risk profiling can be coupled with modelling software to produce a demonstrably superior result, their continued use is difficult to justify. Unfortunately, because portfolio-pickers are commonly (mis)labelled as Risk Profilers, many have assumed, at least initially, that the ProQuest Risk Profiling system is just another portfolio-picker.


ProQuest Takes 'Risk Profiling' Back to First Principles

ProQuest went back to first principles by recognising that the financial planning process required, as a fundamental building block, a valid and reliable assessment of risk tolerance.

Indeed, Harold Evensky describes an understanding of risk tolerance as "...the single most important factor in guiding clients towards a successful investment program."

In 1995, Geoff Davey and Paul Resnik, ProQuest's founders, were members of an FPA sub-committee which conducted and international search for, and review of, profiling systems. While no suitable systems were found, it was clear from overseas research that risk tolerance is a psychological trait, i.e. a relatively enduring way one individual varies from another, and that the assessment disciplines required were those of psychometric testing.

ProQuest was formed and the development process began. With the assistance of the University of New South Wales’ Applied Psychology Unit, we completed the technical development of the testing instrument some 24 months later. More recently, using our database of 6000 completed profiles and extensive analysis of the historical performance characteristics of representative asset allocations, we have developed a methodology for expressing an investor's risk profile in terms of an asset allocation consistent with their risk tolerance.

In order to distinguish what we do from "portfolio picker" risk profiling, we refer to our process as "scientific" risk profiling.

What does a scientific risk profiler actually do?

A scientific risk profiler mirrors what many advisers aim to do, either intuitively or by using non-scientifically derived questionnaires, namely

• form a view as to the client's risk tolerance, by conducting a question-and-answer discussion about the client's attitudes, values, preferences and experiences in matters involving financial risk, 

• feed back to the client a written summary of this view and, if required, amend the summary to reflect the client's feedback (in order to obtain the client's confirmation that the adviser's understanding is accurate and that the adviser may rely on it.)

• consciously or sub-consciously, make a norm-referenced rating of the client's risk tolerance using as norms those derived from the adviser's experience, viz "This client is Low/High/Average, etc. compared to my other clients."

The ProQuest system follows that process with these key differences:

• The questions have been tested for validity and reliability and cover a broader range of topics than would typically be covered by a adviser.
• The questions are in jargon-free, plain English that has been tested for understandability and answerability, and hence explanation/clarification by the adviser is unnecessary.
• Because the questions are asked in a controlled manner without the adviser being involved, interaction with the adviser cannot unintentionally influence the outcome.
• The summary is produced automatically in a structured format by way of a plain English risk profile report.
• The norms-referenced rating is calculated statistically with a known, high level of accuracy against an adult population sample.

Importantly, scientific risk profiling does not replace discussion between adviser and client. Rather, the completed questionnaire and the risk profile report become inputs to that discussion. This approach enables an in-depth understanding to be reached far more accurately and quickly than by discussion alone.

By clearly articulating the client’s risk tolerance in terms that are meaningful to adviser and client the ProQuest system empowers both adviser and client:

• clients are better able to give the adviser clear instructions as to the level of risk they are willing to accept, and
  
  
• advisers are better able to explain and illustrate the practicalities of financial alternatives in the context of the client’s needs and wants.

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An Advisers
Obligation in
Establishing a
Client's Risk
Tolerance

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ProQuest believes that advisers have a professional, legal and ethical obligation to form a view as to
their client’s risk tolerance and to take that view into account when giving advice. For those who share this belief, the issue becomes how best to discharge that obligation.

In "An Adviser's Obligation in Establishing a Client's Risk Tolerance" the Argyle Partnerships' Peter Bobbin gives a lawyer's perspective on the nature and scope of the adviser's obligation.

In discharging it, we believe that the best starting point is an objective assessment of the client's risk tolerance made by way of a scientific risk profile. A risk profile, of itself, is not the determining factor in any aspect of a financial plan. However, if a recommendation involves a level of risk beyond that which the client would normally be willing to accept, we believe that the client should be aware of the mismatch and either consent to it or be given other alternatives.  Without this awareness, no client can be said to have given informed consent to implementation of their financial plan.

Informed consent does not mean that investment risk cannot exceed risk tolerance. But rather that, if it does, the client has been made explicitly aware (in language they can understand - such as the plain-English of the ProQuest Risk Tolerance report) that it does, and of the possible consequences thereof. 

You can read more about ProQuest's core proposition on Risk Profiling in our 'Open Letter to FPA Members', published in the October 2000 edition of Financial Planning Magazine:

Download 'Open Letter to FPA Members'

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Advisers face several key issues when considering how to best develop an understanding of the risk tolerance of their clients.

  What is risk tolerance?
  Why is it important that advisers understand the risk tolerance of clients?
  How should advisers go about obtaining an understanding of their client's risk tolerance?
  What should advisers look for in a risk tolerance test?

The University of Queensland report "Measuring Risk Tolerance: A Psychological Perspective" raises and answers these important questions. 

In choosing the best test of risk tolerance, many questions need to be asked.  How is risk tolerance defined in the test? How has the test  been trialed? How and when is the test to be  used? These questions and many others raised here should be answered in the manual that  accompanies the test. Or, providers of the test must have experts available to answer such questions. 

This paper outlines for advisers the  nature of risk tolerance, and identifies some key issues in choosing a valid and reliable test instrument.  

The paper is authored by Victor J Callan, Professor and Head of the Graduate School of Management at the University of Queensland, and Malcolm Johnson, Lecturer in the Graduate School of Management at the University of Queensland.

National (and international) industry leaders are participating in the current discussion about the role of risk profiling in contemporary financial planning. Here we present the views of five of these industry leaders:

THE PLANNING EXPERT: Harold Evensky, CFP, Evensky, Brown & Katz, Florida, USA. Author of 'Wealth Management', past Chair of the CFP Board of Standards and recently voted as the most influential financial planning professional by readers of Financial Planning Magazine.

"I have had the opportunity for many detailed discussions with the creators of the ProQuest Personal Financial Risk Profiling system and I have reviewed their work as it's progressed. Based on that experience, I have the greatest respect for the end result.

I believe that ProQuest is a world leader in the development of fundamentally sound, yet practical tools that enable practitioners to address the single most important factor in guiding clients towards a successful investment program - their personal risk profile. I look forward to having the opportunity of incorporating the ProQuest system into our practice."

THE FUND MANAGER: Lester Wills, Mercantile Mutual Funds Management.

"We are pleased to be taking a leading role in the provision of an easily-accessible new Australian technology that converges on so many aspects of the current financial planning agenda: improved compliance, superior 'know the client' capability, and accurate needs-based planning. ProQuest adds value to the MercAdviser community."

THE SOFTWARE DEVELOPER: Robert Green, Vision FPS

"We often get comment from planners who use both ProQuest and VisiPlan describing the powerful impact that they achieve in their client meetings by graphically demonstrating the interaction of risk tolerance, projected returns and the long term result on the client's savings, spending and net wealth."

THE RESEARCHER: Graham Rich, Morningstar

"In Morningstar's opinion, ProQuest has set a new international benchmark for investor risk profiling. It is unparalleled in its ability to comprehensively reflect investor attitudes to risk. Morningstar is committed to integrating ProQuest into its range of portfolio building services.

Without a clear and accurate picture of their risk profiles, it is unlikely that investors will be as comfortable with the investment results achieved, or the paths taken to get there. In any event, an adviser is obviously engaging in a high risk activity by not pursuing a quality risk profiling approach."

THE COMPLIANCE SERVICES PROVIDER: Adam Tayler, THP Services

"Having completed over thirteen thousand adviser compliance reviews, the inescapable conclusion is that current methods of assessing client risk tolerance need much improvement. All advisers would benefit from having a systematic and documented approach to risk profiling."

And what your colleagues are saying...

"ProQuest evidences to clients that we are up with modern planning techniques and have a genuine interest in knowing about them."
Fred Barnes, Succession Planning

"Because we forward the ProQuest questionnaire to our prospective clients prior to the first meeting, clients feel that we’re serious planners and are more connected to us."
Rick Maggi, Westmount Securities

"Each question helps focus the client on an issue. It makes our job easier when explaining risk."
Laura Menschik, Millennium Financial Services

"ProQuest improves client communication and subsequent advice."
Murray McLean, Ebony Rose Financial Strategists

"The ProQuest system is comprehensive and user-friendly, and easier to understand than others available. Its computer-generated report provides us, and our clients, with a plain English written record of their risk tolerance. We are confident of gaining a better understanding of how our clients look at investment risks and it is easily adaptable to our asset allocation process."
John Keeble, CIS Financial Services

"ProQuest has helped my staff understand risk profiling and why we need to do it."
Greg Stevens, Greg Stevens and Associates

"When used with existing clients, ProQuest can help them to lift their exposure to shares for longer-term returns."
Anthony Grant, Salomon Smith Barney

"ProQuest enhances a disciplined compliance process, making other staff aware of risk."
Anthony Jones, Templetons Financial Planning

"ProQuest is a more systematised way of doing risk profiling on clients."
Chris Bowyer, Future Strategies

“ProQuest reduces the subjectivity of assessing an individual’s risk profile, confirms that risk tolerance was discussed and records the results. ProQuest assists our firm in reducing the guesswork involved in analysing an individual’s risk profile.”
Suzanne Baldry, Baldry Financial Planning

“ProQuest risk profiling gives our clients a thorough analysis of how they feel about risk. Our clients therefore feel more comfortable with our classification of their profile. ProQuest has helped us lift the standard of our professional advice and service.”
Charlie Sorel, Hillross