Bob Veres, April 27, 2020, Advisor Perspectives

Bear markets beget portfolio losses, unhappy clients and, sadly, lawsuits against advisors. If you relied on any of the popular risk tolerance products to construct that portfolio, here’s how you are likely to fare under the careful scrutiny of an arbitrator.

FinaMetrica:

Now part of Morningstar, Finametrica maps a prospect’s portfolios to FinaMetrica’s famous 1-99 scale of risk tolerance, and identifies a more suitable portfolio if there is a mismatch. The program also creates guard rails on the riskiness of a proposed portfolio based on, among other things, the client’s time horizon for a particular bucket of money, the client’s self-reported investment sophistication and his or her behavior during past downturns. 

My ‘defensibility in arbitration’ score for FinaMetrica: A+.

Riskalyze:

Riskalyze is by far the market leader in the U.S. risk tolerance space. You can use Riskalyze to create portfolios, or choose from its model marketplace, or automate trading activities – all in the name of (company slogan) ‘fearless investing.’ 

When I reached out to Riskalyze, Nicole Keene, chief of staff to CIO Michael McDaniel, replied that ‘none of our users has ever had to provide scientific basis behind their risk tolerance process… Our process requires the investor to confirm, ‘Yes that feels like me,’ and advisors must complete their firms’ new account paperwork accordingly, which also contains a client signature and approval of the results.’ 

In other words, when you go to arbitration, you are relying on the fact that your client signed off on the portfolio you recommended.

My ‘defensibility in arbitration’ score for Riskalyze: C.

Andes Wealth Technologies:

Andes Wealth Technologies is not exclusively a client risk tolerance assessment instrument but helps analyze and build portfolios based on research by Prof. Andrew Lo at MIT. The risk tolerance assessment process is simple: it uses bar charts to graphically illustrate potential returns versus downside risk, based on a normal distribution around an expected return for different portfolio mixes. The advisor can adjust the time period and initial investment, so the client can see potential returns versus possible losses over various time frames.

Once the client chooses a portfolio, the system evaluates the current portfolio and identifies how to align it with the efficient frontier based on the client’s choices. Yang has created an “investor behavior analysis,” which adds another dimension to the assessment. This categorizes investors into profiles such as the passive investor, the trend follower, and the safety seeker, along with less common profiles like contrarians, risk seekers, and adaptive investors.

Andes Wealth is unique in mapping a client to the efficient frontier, offering a graphical representation of the portfolio’s return profile compared to the efficient frontier over time, which helps clients understand their positions relative to the most efficient version of their risk profile.

The program also features a robust investment policy statement generator, useful for advisors needing detailed documentation.

My “defensibility in arbitration” score for Andes Wealth: B+.

Tolerisk Pro:

Tolerisk Pro differs from both FinaMetrica and Riskalyze in that it not only measures risk tolerance (using a 30-question psychometric-based questionnaire), but also risk capacity – that is, the client’s ability to take risk based on current portfolio size and future needs. By combining the two, Tolerisk comes up with a score that evolves over time, as the client becomes wealthier compared to future needs – or, quite possibly, as the market drops dramatically, imperiling the client’s financial future and necessitating a scaling back of portfolio risk. 

My ‘defensibility in arbitration’ score for Tolerisk Pro: C+.

Totum Risk:

Totum Risk measures risk capacity along with risk tolerance (or preference), but the instrument leans heavily in the direction of risk capacity. Instead of using a normal distribution, it prefers to account for fat tails in return distributions by replacing the standard deviation measurement with the Sortino ratio. This unique approach aims to provide a more accurate representation of risk in volatile markets. 

My ‘defensibility in arbitration’ score for Totum Risk: C-.

Bob Veres explores and compares Risk Tolerance Products, featuring Andes Wealth Technologies among others. Gain valuable insights and make informed decisions in your financial journey. Check out the detailed analysis by Bob Veres on Advisor Perspectives here.

Conclusion:

Bear markets are associated with an uptick in lawsuits and arbitration claims. No matter how well you prepare your clients, there may be one or two who will blame you for their market losses, and ask an arbitration panel to reach into your pocket and make them whole.

Further Insights:

For more insights into financial practice management and client services, visit Bob Veres’s blog at www.bobveres.com.

Originally published by Advisor Perspective.