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Risk Appetite Models Face Ultimate Test

The desire for risk exposure is currently at historic lows. According to State Streets global investor confidence index that was published recently and which is measured using changes in actual allocations to equities, institutional confidence declined sharply in September, falling to an all-time low. This lack of confidence is echoed by private clients.

Mike OSullivan, head of research for Credit Suisses private banking business in the UK and with responsibility for global asset allocation, describes risk aversion as acute amongst clients across the industry and sees the impact of recent market events as enduring.

There will be a structural change in what economists call utility function and as clients become more risk averse, they will generally look to firms like us for more portfolio analysis. The approach will become more balanced, Mr OSullivan told WealthBriefing recently.

David McFadzean, director of manager research, RBC Wealth Management, said clients are looking to wealth management firms to cut through the hype in the media.

At RBC, the firm divides a clients risk profile into three elements. The first is their ability to shoulder risk, which will depend on age and financial situation; the second is their requirement or need to take risk to achieve their objectives and the third is their underlying desire to take risk. Clients ability to take risks and, on the flipside, their requirement to take risks to meet their financial objectives has not changed.

Whilst they might perceive that their propensity to take risk has gone down at a headline level, when we talk to clients about whats going on, very often we help them to come to the conclusion that their underlying risk appetite hasnt changed fundamentally, but that they are just more aware of the risks they are taking, Mr McFadzean said.

But whilst risk appetite hasnt changed, the external environment has done so dramatically, which has caused clients to take a step to the left or the right where risk is concerned.

As far appetite for different assets is concerned, Mr McFadzean said there has been a shift down the risk spectrum in favour of government paper and more short term investments. Those who might once have had 100 per cent of all wealth in equities are cutting back and holding a proportion of bonds, whilst those with bonds are looking at money market funds.

However, Mr McFadzean said clients should consider carefully if reducing risk.

They need to ask whether this is really a sea change or a blip on the road to investing, he said, arguing that looking at a performance graph of the Dow Jones Index since near the start of the 20th century requires a magnifying glass to view the Great Depression 80 years on. Clients need to consider time horizons and frequency of observation when considering their risk profile, Mr McFadzean said.

Credit Suisses Mr OSullivan believes that clients are currently more concerned about where they can keep their money safe, rather than what proportion is invested in equities or bonds, a view that is echoed by his peers. He describes his favourite charts are those that take a big look at the investment and therefore keep current events in perspective. He is currently viewing data that date back to 1720 for example. We are currently looking at whether real earnings growth is likely to be 4 per cent or 2 per cent as the outcome will have a huge impact on valuations and where people should put their money, he said.

Mr OSullivan says that a key aspect of his job is reassurance. I spend 80 per cent of my time talking to relationship managers and clients and my role has become much more to explain and inform and give parameters rather than to predict where the FTSE will be in three months time, he said.

We think that clients will look to use more portfolio optimisation. Many of our clients are business people and are curious about what the world will look like. Thematic investing and style investing will become more important, he added.

Ashok Shah, chief investment officer of London and Capital, has not seen a marked decline in risk appetite by investors. These individuals have spent a long time building up their wealth and do not want to have to set up, run and sell another company to make more wealth. Its a stay rich rather than get rich strategy.

Around eight weeks ago, Collins Stewart Wealth Management, meanwhile, noted an increasing amount of nervousness amongst high net worth individuals regarding cash held in bank deposits.

The governments guarantee of the first 50,000 of individuals savings with each institution, means that an estimated 97 per cent of depositors are fine, but it has been suggested that the other 3 per cent of depositors have an estimated 40 per cent of the cash held, said Collins Stewarts Paul Derrien.

With the implication that anything over 50,000 is not guaranteed, the firm is providing clients with guidance on alternatives to cash deposits, such as investing in short-dated gilts.

London & Capitals Mr Shah said that vulnerability around bank deposits is a big concern for HNW clients. Return of capital rather than return on capital is the priority. It is therefore advising that they move to larger banks where governments have provided a capital guarantee on their debts and those banks whose credit default swaps, and therefore credit risks, are low, he said.

RBC Wealth Management says that the safety and security feature of its presentations to new clients, which was once a formality, has become of particular interest.

The question is my money safe? is one that clients probably wouldnt have asked 12 months ago. There has been a sea change in the start of the conversation with clients, but if we do our job properly, at the end of the conversation, clients should be thinking about the same things they always have such as their time horizon and not putting all their eggs in one basket, said Mr McFadzean.

As current markets demonstrate, the ancient verities of spreading risk is something clients, and wealth managers alike, are having to learn all over again.

Tom Burroughes, Editor, Specialists in Wealth Management Jobs, Asset Management Jobs and Private Banking Jobs,