Advisers must use income risk questionnaires for decumulation clients

Speaking to FT Adviser, Moss discussed recent analysis by EV which found advisers needed to be careful when selecting investments for drawdown because there is a lack of transparency around the risk ratings of many UK multi-asset funds and portfolios.

He said: “Advisers need to start using income risk questionnaires, something that is measuring how the client feels about risk to their income.

"The second thing they need to do is to have a method of matching the outcome from the risk questionnaire to investments. Volatility is the wrong measure but currently, pretty much everybody is using volatility. So one of the things that we would certainly advocate is starting to look at income risk and not volatility.”

The analysis by EV revealed that a large proportion of retirees, particularly those with cautious to medium-risk profiles - who account for 85 per cent of retirees per EV’s income risk questionnaire - were exposed to too much risk.

While also finding most multi-asset funds and portfolios used for income drawdown fail to cover the full risk spectrum.

“One of the conclusions we've come to and it’s quite a serious conclusion in the sense that, at the moment, markets are very benign. But if the market had a sustained fall, then you might find quite a lot of clients in significant difficulties. In addition to this they would be saying, we never thought we were taking this much risk or I didn't want to take that much risk,” Moss added.

Chet Velani, managing director of EV, said the big problem was that advisers probably didn’t even know the amount of risk being taken. 

He explained: “That’s because that measure isn’t really out there, we are so used to using volatility as a risk measure because of accumulation. So we're kind of geared up and set up in a world where we're using accumulation processes for decumulation. Advisers don't really have anything out there that can help them understand this enough and that’s the big risk.

“They're effectively giving the advice, putting the clients into these funds but there's a fundamental mismatch, because most people are at a risk profile of five or below. But most funds are a risk profile four or five or above. And that's fundamentally the problem.”

Cashflow modelling

Moss also highlighted the need for firms to take a closer look at their cash flow models.

He said: “People have been using the FCA’s prescribed basis for doing cash flow modelling. The FCA's basis isn't market related, and people are making decisions on a basis that isn't market related.

“Then in the thematic review I discovered a section which said the do's and don'ts of assumptions that you should be using in cash flow modelling. And basically if you read that, you would realise that actually, you should not be using the FCA basis for cash flow modelling.

“So that is a big wake up call, I'm not sure that has actually really sunk in, because it was buried in the thematic review that people need to look very carefully at cash flow modelling.”

Moss believed the FCA should be requiring anybody who produces a cash flow model to have an MOT test.

“Providers would have to go to somebody independent who would look at their model and say 'is this fit for purpose for financial planning?'.

“At least then advisers will be able to say, 'we have done some due diligence, we've seen the report of the MOT test, we think this is an ok model' because at the moment they're in the blind.

“This is not a criticism of advisers, at the end of the day, they can only use the tools that are available.

"There aren't many income risk questionnaires out there. There's no established methodology for risk rating funds for income and looking at their efficiency, that just doesn't exist. And when it comes to cash flow modelling the assumptions are just hidden,” he added.

alina.khan@ft.com