Tests are too subjective and cumbersome, new European research from behaviourial finance experts Oxford Risk shows.

Wealth managers admit that their suitability systems and processes for assessing client portfolios are not suitable for the task, Oxford Risk research reveals.

Insights of behavioural finance – i.e. people mistaking portfolio gains for pure skill rather than also accepting the role of chance, treating losses more emotionally than they do with gains, and following crowd behaviour – have become more widely appreciated. The ideas draw on views about how humans have evolved from pre-history, and are used to explain events such as stock market booms and busts. 

According to Oxford Risk's study with wealth managers across Europe who manage assets of around €327 billion ($318 billion), nearly two out of three agree that current systems are too reliant on subjective human judgement.

Just one in 20 wealth managers questioned in the UK, France, Italy, Spain, and Ireland, disagreed that there is too much subjectivity, while 30 per cent were neutral on the matter, the study shows.

Of the 150 wealth managers that were questioned by research company PureProfile in September 2022, existing suitability processes and systems were criticised for being too cumbersome for responding to rapid changes in clients’ circumstances, with 64 per cent saying systems do not adapt quickly enough.

Just one in 12 believe that current systems can react quickly to changes in client circumstances while 29 per cent were neutral on the issue, the firm said.

Oxford Risk believes that wealth managers need to make more and better use of the available technology to provide improved services to clients, based on understanding their needs through detailed profiling and assessment of suitability.

Greg B Davies, PhD, head of behavioural finance at Oxford Risk said: “It is damning when wealth managers themselves admit that their suitability processes and systems are not suitable for the task.”

“Clearly the last three years have been challenging with the pandemic and ongoing investment market volatility coupled with rising inflation and interest rates. Suitability processes might have felt the strain, and some may simply not be up to the task,” he added. 

“Nevertheless, advisors deserve better tools that can withstand the rigours of modern life. Many detailed and time-intensive cash flow modelling tools are too front-heavy, used at the start of the relationship, but then frequently ignored in cursory annual reviews,” he said. 

“At the start of the coronavirus pandemic, the financial circumstances of all advised clients changed substantially over a period of weeks. Cumbersome tools and annual review processes were inadequate to respond. Life changes fast, tools should reflect this,” he continued.

“It is encouraging that wealth managers recognise there is an issue with their systems, but it will be more encouraging to see how they address the issue given that there are solutions available,” he said.

Oxford Risk, which builds software to help wealth managers and other financial services companies help their clients to make the best financial decisions in the face of complexity, uncertainty, and behavioural biases, has developed proprietary algorithms which rank products, communications, and interventions for their suitability for each client at a particular time.

Its behavioural tools assess financial personality and preferences as well as changes in investors’ financial situations and, supplemented with other behavioural information and demographics, build a comprehensive profile. Oxford Risk’s financial personality tests can measure up to 20 distinct dimensions, of which six reflect preferences for ESG investing.

Oxford Risk believes that the best investment solution for each investor needs to be anchored on stable and accurate measures of risk tolerance. Behavioural profiling then provides an opportunity for investors to learn about their own attitudes, emotions, and biases, helping them prepare for the anxiety that is likely to arise. This should be used to help investors control their emotions, not define the suitable risk of the portfolio itself.