Investment profiling is used by financial institutions and financial advisors to help establish the appropriate level of investment risk for their clients.
It aims to identify the financial products suitable with the client’s investment objectives, risk capacity (or capacity to bear losses), financial knowledge and experience, ESG preferences (preferences for sustainable finance) and tolerance to risk (or risk profile).
Investment objectives
Investment objectives refers to the objectives of the investment like purchasing a house or financing studies. The investment should be adapted to the level of risk required to achieve the client’s goals.
Risk Capacity
Risk Capacity refers to the degree to which one can accept investments in the form of capital gains investments to reach his desired value from this investment.
ESG preferences
ESG preferences refers to the appetite of clients to invest in sustainable finance and have a specific social and environmental impact in their investments.
The European Union has defined a list of specific environmental impacts in its green taxonomy (Climate change, climate mitigation, pollution, biodiversity, marine resources, circular economy). A taxonomy for social impacts should be published in the coming years.
Other taxonomies are also in discussion in other countries like in Canada or in the United States.
Risk Tolerance
Client’s risk tolerance (or risk profile or risk appetite) refers to the level of risk the client wants in an investment. Most of the time, this is expressed by a volatility.
Why assessing investment profiles?
Investment profiling has become compulsory in most countries over the past decades, especially after the 2008 financial crisis, to better protect the retail investors.
More recently, on top of risk profiling, the assessment of ESG preferences (preference for sustainable finance) has become compulsory in the European Union with the new MiFIDII and SFDR regulations.
How do you assess investment profiles at Neuroprofiler?
RISKprofiler, Our Risk Profiling Process
At Neuroprofiler, we assess the client’s risk tolerance through a risk profiling game based on behavioral finance called RISKprofiler.
This risk profiling game lasts from 2 to 4 minutes and is completely adaptive. Each question depends on the answer to the previous question. The output of our RISKprofiler is a risk tolerance utility function which is transformed into a volatility and ultimately simplified into 5 risk profile categories (from very conservative to very dynamic).
A conservative profile could likely focus on conserving wealth instead of aiming for capital gains, with more loss aversion and less risk tolerance. On the contrary, aggressive investors seek financial gain in spite of any investment risk.
Those with a shorter investment horizon or lower levels of capital may be at the conservative edge of the spectrum with limited risk tolerance while those with longer investment horizons or bigger capital reserves will have a higher risk tolerance.
Our RISKprofiler offers 80% of predictability rate for risk profiling, vs. 10% for traditional questionnaires. More than 100 risk profiles can be assessed. The use of behavioral finance is moreover highly recommended by the ESMA (the European financial regulator) to assess risk profiles.
The RISKprofiler can be taken with our without financial advisors.
ESGprofiler: Our ESG Profiling Process
In line with the new MiFIDII requirement, our ESGprofiler assesses the ESG preferences of clients (preferences in terms of sustainable finance) through a behavioral finance game.
As for the RISKprofiler, our ESGprofiler is fully adaptive. Each question depends on the question to the previous question. The output of our ESGprofiler is an isoelastic utility function which will be transformed into a score of general appetite for ESG (from 1 to 10) and scores from 1 to 5 for each specific impact of the financial products (biodiversity, circular economy, pollution…).
As for our risk profiling solution, the ESGprofiler can be taken with our without financial advisors.
MIFIDprofiler: Our MiFIDII/LSFin/IDD Profiling Process
In order to comply with all the requirements of the European financial regulations such as MiFIDII, LSFin and IDD, ESG and risk profiling is not enough. Financial institutions should collect additional information to be sure that the offered investment is fully in line with the client’s investment profile.
In line with these requirements, Neuroprofiler offers a MIFIDprofiler which assesses client’s financial knowledge and experience, financial situation, risk capacity (capacity to bear losses) and investment objectives.
As for our ESG and risk profiling solutions, our MIFIDprofiler is user-friendly and fully adaptive. Most questions depend on the answer to the previous question.
For instance, to assess financial knowledge, we start with very simple questions about bonds and shares. More difficult questions about derivatives and structured products will be asked only for more expert clients. For existing clients, most fields can be pre-filled, like for questions about risk capacity, in order to make the user experience as short as possible.
RECOprofiler: Our Recommendation Process
Based on the output of the ESGprofiler, RISKprofiler and MIFIDprofiler, our RECOprofiler can recommend suitable financial products like funds, portfolios or private equity products.