This latest injection of market uncertainty has underlined a fresh impetus to the initial suitability assessment of drawdown. This suitability should be reviewed at least annually, and most advisers will be reviewing clients in drawdown regularly, some might do this quarterly.
By committing to regular reviews, you have more opportunity to advise small changes to ensure clients remain on track to meet their income requirements. In an environment where inflation is forecasted to continue rising well into 2023 and the market outlook remaining uncertain, the importance of regular reviews can not be emphasised enough.
For some clients though, significant reductions in investment sustainability scores may bring about a need to re-evaluate risk appetite and capacity for loss.
Dialling up risk
Increasing a client’s risk level is one way to potentially generate higher returns, but is this suitable practice and how would your clients feel about an increased exposure to risk during periods of higher volatility?
This is simple investment fundamentals in that to earn higher returns, you must be willing to increase your exposure to higher-risk investments. This higher risk may yield higher returns over both the short and long term, but it will almost certainly yield periods of greater underperformance and that is an undesirable outcome for many individuals.
A client’s attitude to risk and capacity for loss can naturally change over time, which is why it is so important to review these as part of annual reviews. Periods of uncertainty and high inflation have the potential to serve as a catalyst for shifts in risk appetite and capacity for loss.
However, is it possible to increase returns without increasing clients’ exposure to risk? Ensuring clients are broadly diversified could be an alternative to shifting the risk dial.
The primary reason for diversification is that it reduces concentration risk and ensures portfolios are more resilient to market twists, but a broad diversification approach can also deliver more reliable investment outcomes.
More broadly diversified solutions underperformed the more basic approaches significantly in the deflationary Covid shock over 2020.
However, over the inflationary period of 2021 and into 2022 the broader diversification has proven to be much more resilient and recouped the shortfall during the post-Covid recovery. This suggests that higher returns can be achieved without exposing clients to unnecessary additional risk.
Focus on the tried and tested
There are certain investment fundamentals that have been around for a long time and for a very good reason too. The problem is that ‘investment rules’ often get thrown out of the window amid a market crisis and the irony is that those are the very times these rules should be adopted.
We should take learnings from these rules to add value to client conversations and advice processes.
While we cannot control what inflation does or indeed influence unstable geopolitics, we can choose to stay rational, disciplined and focused on the client’s individual needs – whatever those needs may be.
