The way that financial advice is given in South Africa is changing. This is not just because of regulation like RDR, but because both clients and advisers are thinking differently about where the real value of advice lies.
Speaking at the Glacier i3 Summit in Stellenbosch last week, the president of Wells Fargo Asset Management, Nicolaas Marais, pointed out that this change is happening in many parts of the world. It is a move from recommending products, to discussing and designing outcomes and solutions that meet specific needs.
“In the US, 71% of advisers are moving towards delivering outcomes,” said Marais. “They are thinking about liabilities and cash flow needs and working out solutions.”
This, he pointed out, has been the case in the institutional space for years, where consultants start by looking at a pension fund’s liabilities and then design a portfolio that will match those. This thinking is now starting to take hold in the way advisers interact with individual clients as well.
In other words, advisers need to think less about the importance of identifying and recommending different asset managers based on relative performance and more about how to construct portfolios that deliver an individualised outcome.
“We’re not investment managers,” said Brian Foster, a financial planner and the co-founder of Beyond RDR. “We have to let go of picking funds and telling clients that’s where our value is because I think that’s going to get us into trouble. Some of the best asset managers in the world struggle to add value, so if you’re a small independent advice firm what chance do you have really? That isn’t where we are adding our value.”
An important part of this process is a discussion between the adviser and the client about risk.
“In the financial services world we tend to talk about risk in terms of volatility, but what about the risk of not achieving the thing that matters to you most?” Foster noted. “As advisers we must have the right conversations and define together with the client what they are really worried about. Generally they don’t care about volatility. What they care about is losing money. They are not risk averse, they are loss averse.”
He added that risk profiling of clients is generally inadequate. This makes it potentially one of the biggest problems advisers face.
“One of the things I see financial advisers doing poorly is risk profiling,” Foster argued. “We try to have a step by step process, but what we are missing is the conversation that needs to take place.”
He noted that there are four elements to a risk profile, and these can’t all be determined by checking boxes on a questionnaire.
“The first is what is the risk needed to achieve a certain return, and that is a financial construct that has nothing do to with attitude to risk,” Foster pointed out. “There is risk capacity, which is about the clients’ capacity to withstand the risk given their position. Again, that is not a psychological construct. It is a financial one.”
Where the client’s attitudes become important are in their perception of risk and their risk tolerance. However, these alone can’t determine what kind of portfolio they need.
This can only be achieved by melding all of these factors together. Filling in an attitude to risk questionnaire that on its own leads to an asset allocation model does not take into account the realities of the client’s financial situation or market realities.
A key part of this is also managing client’s expectations. Client’s need to understand the relationship between risk and reward, but also what is realistically achievable.
This requires advisers to not only make sure that their clients understand upfront what their portfolio is designed to achieve, but also that the adviser communicates regularly about its progress.
“The less interaction you have with your client, the less there is an honest discussion about what is actually achievable, the more you are at risk disappointing them,” said Marais.
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