A greater emphasis on risk over financial goals has underlined the challenges facing UK financial advisers in changing client attitudes towards investing, according to a new report by investment research provider FE, parent of FE Trustnet.
The ‘Advice on Risk and Reward’ report surveyed 210 financial advisers from across the UK over how they communicate, measure and manage risk for clients.
The report found that, by averaging results across its sample, advisers typically place a 60 per cent emphasis on how risk-focused a client is, compared with a 40 per cent focus on goals and objectives.
“It is unclear if this is because of a natural risk aversion in investors or if they are not prioritising their desired outcomes,” the report noted.
The report also showed that advisers were reluctant to encourage clients to take more risk to enable them to achieve their goals.
Just 17.6 per cent of advisers often encouraged clients to take greater risk, while 71.3 per cent occasionally did so.
Rob Gleeson, head of research at FE (pictured), said: “Communicating the various types of investment risk to clients is complex and a daily challenge for most advisers. 
“The reality is that most investors dislike losses much more than they enjoy any gains and advisers are mindful of this.
“Centring the conversation around financial goals may require them to explain to their client that a change in their attitude to risk is needed to achieve them. Our report suggests that this is a conversation advisers are cautious to engage in.”
Gleeson said advisers may fear regulatory comeback even though it is unlikely providing correct processes have been followed and documented.
While attitude to risk questionnaires were the main tool for advisers to explain risk to clients, with 73.7 per cent using them, volatility/standard deviation was the next most commonly-used tool.
According to the report, 63 per cent of advisers regularly use volatility as a measure of risk when compiling portfolios for clients.
Do you regularly use volatility as a measure of risk when compiling portfolios for your clients?
Source: FE
However, despite an increased focus on risk, some advisers are not setting risk targets.
The report found that 42 per cent of advisers used a risk target when building a portfolio. A further 34 per cent sometimes set risk targets while 25 per cent did not use them at all.
The lack of risk targets by some advisers would suggest that “managing volatility to a specific target is clearly not a top priority for advisers”.
“This is at odds with advisers’ expressed concerns elsewhere in the research that managing volatility is a priority, suggesting that some advisers understand volatility is important but are not clear about how to manage it effectively,” the report noted.
“When asked to describe how they manage volatility, most say they do so through selecting a diversified portfolio at the outset, yet few said they continue to monitor volatility on an ongoing basis.”
Advisers who do not set risk targets are more likely to blend model portfolios or multi-asset funds to blend away ‘manager risk’, according to the report’s authors. While two-thirds of advisers who use risk targets and blend do so for diversification purposes.
Indeed, the report found that 72 per cent of advisers combined multiple model portfolios or multi-asset funds to increase diversification, reduce manager risk or to hit risk targets.
However, the authors noted that combining multi-asset funds was a “blunt instrument for managing risk, potentially adding layers of unnecessary cost and leading to sub-optimal strategies through a compounding of risk reduction by leaving an investor open to an insufficient level of risk in their portfolio”.
Among advisers the best products for managing risk were their own in-house solutions rather than multi-asset funds or external model portfolios.
Which products do you think are better at managing risk?
Source: FE
Participants in the survey also believed their own in-house investment solutions were better a providing a return than external providers.
Ongoing monitoring of risk was another area highlighted by the report with some surprising findings.
More than three-quarters of advisers do not manage risk in their clients’ portfolios by monitoring the extent to which it is underperforming, the report revealed. Although 69 per cent rebalance portfolio to their target asset allocation on an ongoing basis.
Monitoring risk can be challenging for advisers, however. As highlighted below, sequencing risk – the risk of receiving lower or negative returns when withdrawals are made, particularly of concern at retirement – emerged as the most difficult o monitor.
Source: FE
Liquidity risk was the second most difficult risk for advisers to monitor, highlighted more recently by the gating of several property funds in the wake of the EU referendum last year.
Mika-John Southworth, director at FE, said the report highlighted “both the growing professionalism of the advisory industry and some significant inconsistencies in managing and communicating risk”.
“These issues must be addressed to ensure clients have realistic and achievable financial goals and have a clear understanding of potential gains and losses along the way,” he added.
“A change in the conversation around risk is needed to move it on from a narrow dialogue centred around volatility and attitude to risk.
“All parties – advisers, fund managers, data analysts and technology providers – should do more to ensure the debate around risk is a balanced and holistic one.”