# "attitude to risk" vs. "capacity to handle losses"



## Brendan Burgess (25 Apr 2012)

In most discussion of risk and communications between investment advisors and their clients, the topic seems to be "what is your attitude to risk?". The broker seems to accept the attitude as described by their client. 

When discussing this with people, I have always felt that it was more important to discuss their capacity to handle losses. I have seen some very risk averse people who, in my opinioin, should not be risk averse. 

I came across [broken link removed] yesterday produced by the FSA in the UK. I haven't managed to read it all yet, but it 

_Assessing Suitability: Establishing the risk a customer is willing and able
to take and making a suitable investment selection_

I had not seen the distinction between willing and able being made before. I presume it has been discussed. Has anyone a useful link to a discussion of the topic?


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## Marc (25 Apr 2012)

Brendan

I have written a white paper on this as a result of the FSA research if you send me an e mail to remind me I'll forward a copy to you when I get back to the office.


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## ixus (4 Jun 2012)

Without reading the paper; this has been extensively covered by Kahnemann, Tversky et al a long time ago in Behavioural Finance. 

Framing is one way of looking at what you discuss. It's a pretty enthralling area and one that answers a lot of the questions as to why we have ended up where we are IMHO.


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## Marc (5 Jun 2012)

Agreed I have just read Danny's latest book and there is an interview with him in Spiegle online  

http://t.co/0J0eTiyT


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## Brendan Burgess (8 Jul 2013)

I was asked for advice by someone who had invested all their cash in The Bank of Ireland Cobbetts Fund and have lost it all.

In my view, this fund was totally unsuitable for them, but their bank sold it to them.  They signed a Fact Find which said that they were prepared to take "a high element of risk; and that a geared property fund had  greater volatility"

I don't think that they have a chance with a complaint to the FSO.

But I do think that banks or financial advisors should not be able to escape their obligations to give good advice by getting customers to sign such documents - which they often sign without reading. Most retail customers rely on the advice they are given orally. 

Of course, a customer is entitled to invest their money wherever they want. 

But if a customer chooses to invest all their money in a geared property fund, the advisor should be obliged to write a letter of unsuitability along the lines of 

"You have chosen to invest in the Cobbetts Fund. This is highly risky and we consider that this is not suitable for you. Please sign below to acknowledge that you are investing in this, despite our advice to the contrary" 

Should the Consumer Protection Code be changed to focus more on the advisor assessing the customer's ability to handle risk, rather than the customer's attitude to risk? 

Brendan


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## Monksfield (17 Jul 2013)

Agree strongly that the CPC has the balance wrong between attitude to risk and capacity to bear risk. The UK has the emphasis the other way around.

Having said that the CPC does oblige regulated entities to consider and document "if the consumer is financially able to bear any risks attaching to the product or service".

If the Cobbetts fund was wrapped as a unit-linked fund BOI or whoever offered the advice would have been obliged to consider ability to bear risk, unless Execution Only.{ If Cobbetts was introduced by the bank/advisor could not be Execution Only.}

If not, the common belief is that there is/was no onus on the advisor/product promoter. In many cases where the consumer is dealing with a regulated financial services provider the distinction between what is and what is not covered by regulation is arcane - they don't know and trusted the bank/stockbroker/advisor. The FSO definition of what may be complained of extends beyond that which is regulated provided the advice came from a regulated FS provider : this makes eminent sense.

It would be interesting to see the courts test whether someone who was advised/sold something which is outside regulation but clearly an investment (e.g. property syndicate) had a duty of care analagous to that which would apply to an investment through a regulated structure.


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## ashambles (22 Jul 2013)

I think some sort of approach like some US trading platforms works fairly well. You're asked to disclosed your personal wealth, and only offered say options trading if your wealth is above a certain level. Nothing to stop you lying but that's your responsiblity. So the customer is showing their capacity to handle losses themeselves. 

If a bank gives a 30 min sales push of a product, it's very easy for them to give 29mins on the upside with 1m of warnings mixed in. If a customer has been convinced by the spiel and agrees verbally then by the time it comes to signing they're probably feeling committed anyway regardless of the small print. 

The bank describing the Cobbett fund as having "greater volatility" is the sort of thing I've heard when having similar products pushed my way. While covering themselves legally it's very unlikely that the customer will understand just how "volatile" these products can be. In my own experience they certainly did not mention similar investments could go to zero with even a modest decline in the underlying assets, something that would have caused a bit more alarm than being told there's greater volatility in these funds. 

They show you charts showing what happens when things went well in previous investments, however you get euphemistic terms to cover the downsides. So clear pictures of upside, vague words to show downside. 

Betting on black on a roulette wheel also has "greater volatility" than most investment funds. As it turns out these funds were probably closer to betting than investing. 

As an investment I don't see them being useful even for people who can absorb the downside risk, you're looking at a range from losing everything to possibly making around 60% pre-tax over 5 years. When I was pushed similar products a few times I wasn't interested, mainly I think because fees and charges seemed to be swallowing huge amounts of the potential returns.


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