Understanding Client Needs: An Investment Manager's Guide

Investment managers are responsible for handling their clients' financial planning, investing, and portfolio management activities. They devise strategies and execute trades within a financial portfolio. To figure out their client's needs, investment managers must first identify their client's risk tolerance, which is how much risk they can handle before losing sleep at night. This is an important first step as it helps determine how much money to divide into stocks versus bonds or other securities that may provide more stability during a market downturn. The next step is to choose investments for a client. Once an investment manager determines what portion of the investment portfolio to separate into each type of asset class, they then decide on the specific stocks or bonds to purchase for their client. Finally, investment managers must monitor the performance of the chosen investments.

Understanding client goals

When identifying client goals, it is essential to consider both short-term and long-term objectives. Short-term goals typically focus on immediate needs, such as paying off debt or saving for emergencies, while medium-term goals may include saving for a home or education. Long-term goals often encompass retirement planning and wealth management.

Assessing the client's financial situation is an integral part of understanding their goals. This involves evaluating their income, expenses, asset allocation, and current financial status. By doing so, advisors can identify any gaps or areas of concern and offer customised solutions.

Another critical aspect is evaluating the client's risk tolerance, which includes their risk capacity, attitude, and perception. Understanding a client's willingness and ability to take on risk is essential for recommending suitable investment strategies. Factors such as age, financial stability, investment experience, and personal attitudes influence risk tolerance.

By conducting a thorough CNA, investment managers can gain valuable insights into their client's goals, enabling them to develop financial plans and strategies that align with those goals. This process helps build trust and long-term relationships with clients, ensuring that their investments are optimised to meet their financial objectives.

Assessing risk tolerance

Assessing a client's risk tolerance is a crucial step in financial planning and investment management. It involves understanding how much risk an investor is willing and able to take, which is often influenced by their personality, values, financial situation, and life circumstances. Here are some key aspects to consider when assessing a client's risk tolerance:

Risk Questionnaires and Open-Ended Questions

Start with a risk questionnaire to understand the client's basic risk tolerance. Then, use open-ended questions to dig deeper into their thoughts, feelings, and experiences related to risk and investments. This helps in understanding their risk capacity and emotional resilience.

Measurable Factors

Consider measurable factors such as the client's time horizon, age, income, and family circumstances. Generally, a longer time horizon allows for a riskier portfolio, while older clients or those with shorter timeframes may prefer less risky investments. Income stability and family obligations also play a role in risk tolerance.

Personalities and Values

Assess the client's personality and values, which are less quantifiable but crucial in understanding their emotional response to market volatility and losses. Some individuals are more cautious, while others are adventurous. Their reactions to actual or potential losses and their long-term goals will influence their risk tolerance.

Regular Reassessment

While an individual's fundamental attitude towards risk may remain consistent, their life circumstances can change. Thus, it's important to regularly reassess a client's risk tolerance, especially after significant life events or financial changes. This ensures that their investment portfolio remains aligned with their comfort level and financial goals.

Investment Manager's Role

An investment manager plays a vital role in helping clients assess their risk tolerance. They design portfolios that meet the client's interests, risk tolerance, and investment goals. They also provide advice and guidance to ensure that the client's investments are optimized and aligned with their financial objectives.

Ethical restrictions

• Honesty and Fairness: Investment managers must conduct themselves with honesty and fairness when dealing with clients. They should provide full disclosure of any crucial information related to the client's accounts and transactions.
• Conflicts of Interest: Investment managers should avoid conflicts of interest and keep their personal activities separate from their business dealings. They should also ensure that all clients are treated fairly and impartially, without giving preferential treatment to certain clients that may negatively impact others.
• Diligence and Care: Investment managers have a duty to exercise reasonable care and prudent judgment when managing client assets. This includes performing thorough research and analysis to make decisions that align with the client's objectives and risk tolerance.
• Price Manipulation: Managers must not engage in practices designed to artificially inflate trading volume or distort prices. This includes spreading false rumors, misleading information, or buying large positions to manipulate prices.
• Client Objectives: It is essential to understand and evaluate the client's investment objectives, risk tolerance, financial situation, and constraints. This information is typically outlined in an Investment Policy Statement (IPS), which helps managers choose suitable investments for the client.
• Compliance with Regulations: Adherence to regulatory standards, such as the Investment Company Act of 1940, is crucial. While some guidelines may not be legally mandated, following the spirit of the law and establishing clear ethical standards helps set expectations and maintain trust with clients.
• Code of Ethics: Investment firms should adopt a written code of ethics that sets out standards of conduct, promotes compliance with fiduciary duties, and addresses conflicts arising from personal trading. This code should be regularly reviewed and enforced to maintain ethical behaviour among employees.

Investment time horizon

Time horizons are largely dictated by investment goals and strategies. For example, saving for a down payment on a house over two years would be a short-term time horizon, saving for college would be a medium-term time horizon, and investing for retirement would be a long-term time horizon.

The longer the time horizon, the more aggressive an investor can be in their portfolio. Generally, the longer the time horizon, the longer the power of compounding has to work, and the more time there is to recover from any short-term downturns. For instance, a young couple saving for a down payment on a house in a few years would want to go with something relatively conservative, like a money market fund, to avoid any sharp swings in stocks. On the other hand, a long-term time horizon of ten or twenty years, or even longer, allows investors to take greater risks in exchange for greater rewards.

Time horizons also vary according to the time by which an investor begins investing. For example, an older investor in the final stages of preparing for retirement may have a short time horizon of one to three years and will be highly risk-averse. They will want to focus on low-risk investments that can easily be liquidated and converted to cash.

It is important to note that each type of investment carries different forms of risk, which should be factored into the investment strategy. These include inflationary risk, interest rate risk, business risk, default risk, and market risk.

Liquidity needs

Investment managers must understand their client's liquidity needs to ensure they can meet their cash and collateral obligations without incurring significant losses. This involves assessing the client's ability to convert assets into cash without compromising their operations or financial health.

• Time Horizon: The length of time a client can stay invested is crucial for defining an investment strategy. Generally, the longer a client is invested, the more protected they are from short-term market fluctuations. For clients with catastrophic injuries, the time horizon may be unclear, but investment managers typically recommend a minimum investment period of five years for equity markets.
• Risk Tolerance: Investment managers should help clients establish their risk tolerance, including their appetite for risk and capacity for loss. While no investment is risk-free, a well-balanced and diversified portfolio can reduce 'specific risk', which is the risk of loss from a single investment or asset class. The less a client can afford to lose, the lower the risk the investment manager should pursue.
• Ethical Restrictions: Investment managers should consider any ethical restrictions or exclusions the client may have. Ethical investing typically involves applying negative and/or positive investment screens to select or rule out companies based on specific environmental, social, and governance (ESG) criteria.
• Liquidity Restrictions: It is important to specify any liquidity restrictions at the outset. Investment managers should ensure that clients hold enough funds in cash to avoid the need to withdraw from the portfolio at inopportune times.
• Liquidity Measurement: Investment managers can use liquidity measurement ratios to evaluate a client's liquidity risk. This involves comparing liquid assets (those that can be easily converted to cash) with short-term liabilities to determine if the client can make excess investments, pay out bonuses, or meet debt obligations.
• Over-Leveraging: Investment managers should assess if the client is over-leveraged, meaning they have more debt obligations than cash on hand. Over-leveraged clients have higher liquidity risk and less flexibility in managing their assets.

Frequently asked questions