How Asset Class risk profiling with GLP works in simple terms and improves the outcome relationship with your client.
GLP stands for Growth Loss Profile and is the Patented program of the system.
GLP is NOT designed to be the 'be all to end all' of Risk profiling tools however is it designed to ensure effective management and control of both the moving asset allocation of an investment with the moving preferred asset allocation of a client based on life-cycle, personal intuition of risk and overall desired outcome.
When properly used GLP profiling will;
- Remove client focus on current or expected returns
- Focus client activities on options in client/adviser control.
The key factor within this profiling method is based on Behavioral Finance.
In relation to the methodology of GLP (Growth /Loss Profiling) that we use, we developed GLP theory based on Dr Kahneman (Noble Prize Winner for economics 2002) theory of Behavioural Finance studies which focused on the emotion and intuition decision making process which in certain circumstances leads to systematic and predictable errors.
Kahneman identified that people use two minds in relation to financial decisions – The Intuitive Mind and the Reflective Mind.
From his study we were able to identify how the Reflective Mind acts to disengage clients in a period of poor (or perceived poor) market conditions. During times of unsettled markets, clients often react to these conditions with a ‘knee jerk’ decision of ‘selling in the low’ period and alternatively, ‘buying in the high’ period.
Since 2008 we have studied the relationships between Adviser and Client (interviewing 370 Advisers & 1500 clients), focusing on the asset allocation of strategy and found it interesting that the industry continues to be fixated on Investor Risk profiling by Asset Class yet it had not addressed the issue of performance within the asset class/allocation, hence the development of GLP.
Risk Profiling by definition selects the asset spread that an individual believes (at the point of time that the profile was completed) reflects what they would be ‘comfortable’ with. Many suggest that an individual’s Risk profile never changes but as Kahneman identified, a change does occur when the ‘Reflective Mind’ begins to process the outcomes of a situation.
Up until 2008, world markets were in a period of unprecedented growth modes (15 years +) and as such investors reduced the focus on risk, many Advisers reduced their focus on risk and…, well we know what happened to investors worldwide.
Studies in the USA since 2008 have shown that the majority of investors did not fully understand the level of risk associated within their profile and many have changed their profile due to the markets poor performance. This is simply ‘Inertia’ which is referred to as a person’s DNA to Loss Aversion in all matters of life, however in the investor world, we believe that it is the level of Loss Aversion that should be the foundation of the ongoing relationship between the Adviser and Client.
We all understand that the ability to identify, measure and exploit risk is critical to successful investing. Even when markets are performing strongly and everything appears to be instantly ‘turning to gold’ there is always an underlining risk. How that risk is managed is the key; and to be able to manage risk you need to be able to monitor the risk.
GLP is the method of measuring the underlining risk by profiling the clients’ capacity to sustain a level of growth or loss that the client is prepared to undertake within their Asset Allocation. It performs a range of calculations daily and in a dynamic fashion to reflect the changing investment market and matches these changes within the asset allocation profile of the client.
To enable this to happen, GLP uses 3 methods;
- The Risk profile of the individual based on asset class/allocation
- The Asset Allocation of the Risk profile is overlayed on the selected investment asset allocation
- The capacity of an individual to sustain a growth or loss within that investment is stored and overlayed.
Although the risk profiling we use is based on industry standards, we have expanded the limitation of risk profiling by using the Asset Class/Asset allocation as a means to underpin the selected fund. If the asset allocation of the fund moves outside of the stored asset allocation of the client then an alert is sent to the adviser.
The alert identifies that the nominated fund is out of alignment with the profile of the investor, when the fund performance risk drops to a pre-determined and mutually agreed level that an investor does not have the capacity to sustain.
The system can be turned on and off and override if the adviser sees a reason to disconnect the function.
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