What’s wrong with risk assessment
The FSA has assessed a sample of 19 discretionary managers’ client files and found faults with 80% of the files. Before you panic and think the industry doesn’t know what it is doing, you ought to pause and consider whether the supervisory staff at the FSA knows how to assess the industry’s risk assessment process. Aside from obvious problems supervising the banking sector, why wouldn’t it be able to handle something as uncomplicated as this?
In my recent article in Citywire Wealth Manager I explain that the FSA is handicapped by assuming the problem is uncomplicated when it isn’t. It therefore provides guidelines to firms that are likely to lead to inefficient risk choices by both agents and clients. We can only guess at whether this leads discretionary clients to take too much or too little risk and which would do the most harm.
Citywire’s title was Why wealth managers are to blame for suitability crackdown. I blame the industry rather than the FSA not because they are our regulator but because they take their cue from the industry. If we adopt, as standard practice, facile processes for assessing personal risk preferences, assessing portfolio risks and then for ensuring the two match up for each client, the FSA is likely to adopt facile guidelines for each and apply them in a facile way. If this is what the FSA has done, and if it has distorted in any way its shocking findings, and if we want to make sure the FSA does not undermine investors’ confidence (as this exercise may have done), we first have to make sure our processes are fit for purpose. Denial is not without a cost.
Obviously we think we have thought about the problem, we have come up with different ways of defining it and different solutions (heavily quantitative) for dealing with it. As regular followers of our blogs will know, both draw heavily on Liability Driven Investment techniques.