Mind maze. Understanding the needs and goals of the client.

“Being an investor is not natural. It requires people to be patient and defer consumption and that’s not easy to do. Our brains aren’t wired for it”

Ryan Murphy, Morningstar

“If you look at a lot of the larger institutions, they have really facile questionnaires which don’t probe the inconsistent views of investors”

Harold Geller, Geller Law

In Partnership with

The KYC conundrum – what do clients want?

Finance industry experts discuss the impact of new KYC regulations and the rising importance of understanding client behaviour and preferences

Read on

Harold Geller

Geller Law

Jason Pereira

Woodgate Financial

Ryan Murphy

Morningstar

Ian Tam

Morningstar

Industry experts

AS REGULATORS in Canada and around the world ramp up oversight of the finance industry, they are increasingly tightening rules governing financial advisors and how well they know their customers. For advisors who are already operating within a highly complex and risk-sensitive industry, it’s important to understand what these changes will mean. A few key questions immediately come to mind. How will an advisor define a client’s risk profile under the new rules? How can they determine what a client wants (especially when a client doesn’t always know what they want)? And, finally, what impact will sustainable investing and technology have in the months and years ahead? To answer these questions and more, Wealth Professional hosted a webinar (The KYC conundrum: When clients don’t say what they mean – or mean what they say. Morningstar Special) featuring several leading experts from the finance industry. Led by Ian Tam, director of investment research, Canada, at Morningstar, the discussion was attended by Ryan Murphy, Morningstar’s global head of behavioral insights; Harold Geller, a lawyer and member of the OSC Senior Expert Advisory Council; and Jason Pereira, an award-winning financial planner, portfolio manager, TV host, and podcaster.

Murphy, who has spent years studying human behaviour at the University of Zurich and Columbia, suggests that advisors take a step back and ask both themselves and the client a fundamental question: why did they choose to invest? “Being an investor is not natural,” he explains. “It requires people to be patient and defer consumption and that’s not easy to do. Our brains aren’t wired for it.” Investing also requires people to overcome our aversion to uncertainty because that’s where the rewards are. So, Murphy asks, if investing isn’t a natural or comfortable decision, why is a client deciding to invest? This question is the starting point for a discussion about risk and goals.

Tam kicked off the hour-long discussion by highlighting the two core measures of a client’s risk profile, according to regulators in the US and Canada: one, risk tolerance, or an investor’s attitude to risk; and two, risk capacity, which is their financial ability to withstand losses. Beyond these two core measures, Tam asks, how should advisors be approaching risk with their clients?

Pereira agrees. Really knowing your customer takes more than providing a list of multiple-choice questions or a homemade survey based on dubious methodologies. Advisors would be well-served by reading Shawn Brayman’s paper about risk profiling in Canada, he says. Brayman

identified a wide range of risk characteristics including risk tolerance, loss tolerance and inversion, risk composure, risk perception, and risk preference, among others. Pereira, who is a founding president of the Financial Planning Association of Canada and three-time winner of the Global Financial Planning Award, also highlights the need to prioritize financial planning before moving on to investment decisions. An advisor must take in the totality of the client, along with their needs, desires, and goals, before any recommendations are made, he says. “It’s the cart before the horse,” Pereira says. They might have a five- to 10-minute conversation and then present the portfolio before discussing a financial plan, he says. “How does it make sense that the financial plan is the second step? Imagine going in to talk to your doctor and they write a prescription before you say a word.”

This failure to understand a client’s needs is a recipe for legal problems down the road, says Geller, a lawyer who has helped over 1,500 Canadians recover financial losses from banks, investment dealers, portfolio managers, and life insurance agents. “The most common error is a flawed KYC process,” Geller says. “If you look at a lot of the larger institutions, they have really facile questionnaires which don’t probe the inconsistent views of investors.” This means an advisor’s relationship with a client is already

starting with a problem, he says. One of the first things an advisor can do is use plain language to describe investments. For example, what does a “time horizon” mean to an investor? “It could be many different things and open to misinterpretation,” Geller says.

unexpected losses take on another dimension when it comes to investing sustainably. This is because an investment that adopts a preference for certain social or environmental goals may involve some trade-offs with maximizing financial returns. Investors have to understand that the further you depart from a market-based portfolio, the bigger the chance that returns won’t match expectations, Pereira says. “We have clients that for very deeply personal reasons want nothing to do with fossil fuels. But then oil went on a tear and there was a period of time when everybody else was making money because it was oil and gas driven.” As a behavioural scientist, Murphy has spent a great deal of time understanding the motivations of investors. One of the distinctions he highlights is the difference between a stated preference and the investor’s actual preference. “You can’t ask people to what degree they’re a proponent of child labour on a scale of one to five because nobody answers that question in this way,” Murphy explains. But you could present two portfolios where one avoids oil and gas yet has slightly less returns, while the other might have higher returns yet more exposure to oil. By providing a series of these comparisons, you can start to identify the strength of their preferences.

Financial advisors are facing rapid changes in regulations that are forcing them to change the way they work with clients. Pressure is also coming from technology. Whether it’s due to artificial intelligence or automation, there’s an expectation among executives and engineers that fewer advisors will handle more investors. But this tendency of new technology to speed things up and allow people to do more with less is running directly into another trend in the finance industry. “We’re actually seeing more advisors servicing fewer people because of higher levels of personalization, custom care, and planning,” Pereira says. “The future is being the bridge between the technology and the client.

Research shows clearer goals can increase client wealth by 15%

On May 16, 1984, Joe Mansueto founded Morningstar in his Chicago apartment. Today, Morningstar is a billion-dollar company with more than 10,000 employees around the world. For over 38 years we’ve worked tirelessly to empower investors to make confident investment decisions and achieve the success they deserve. We’ve done all of this with a steadfast investment philosophy and independent view that’s unshakeable.

Find out more

Harold Geller is an expert on legal issues affecting investors and those with life insurance. Specifically, he assists investors, insureds, and their lawyers with the analysis of claims, prosecution, and settlement of claims in the civil courts and the office of the Ombudsman for Banking Services and Investments. Geller has assisted over 1,500 Canadians recover financial losses from banks, investment dealers, portfolio managers, life insurance agents, life insurance agencies, and life insurers.

Geller Law

Harold Geller

Jason Pereira is a well-known and accomplished financial planner and industry advocate. He holds nine industry designations and has been either a finalist or a winner of over 40 industry awards, including the first and only three-time winner of the Global Financial Planning Award. His commentary and writing have appeared in every major media outlet in the country, and he currently serves as a columnist and advisory board member of the The Globe and Mail’s Globe Advisor.

Woodgate Financial

Jason Pereira

Ryan Murphy is Morningstar’s global head of behavioural insights. His research is interdisciplinary, bringing together methods from experimental economics, cognitive psychology, and mathematical modelling. The focus of his research is to better understand how people make decisions, especially about risk, money, and investing. His current work centres on measuring people’s preferences, goal-centric investment planning, and developing methodologies and frameworks that improve decision quality. Before joining Morningstar in 2016, Murphy was the chair of decision theory and behavioural game theory at the Federal Institute of Technology in Zurich and a visiting professor at the University of Zurich’s economics department.

Morningstar

Ryan Murphy

Ian Tam is tasked with evangelizing Morningstar’s thought leadership across multiple stakeholder groups within Canada’s investment industry inclusive of individual investors, advisors, asset managers, industry trade bodies, and regulators. He is also currently the chair of the Canadian Investment Funds Standards Committee, which oversees mutual fund, ETF, and segregated fund classifications in Canada. Prior to his current role, Tam was a sales director for CPMS™, Morningstar’s quantitative screening and back-testing platform for equities. Before joining Morningstar in 2014, Tam worked for Thomson Reuters’ Financial and Risk Division.