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Ten years on: Five stars for Barclays' Financial Personality Assessment (FPA)
16/05/2017 , Ian Orton

Behavioural finance is now an accepted part of the investment management lexicon. Nonetheless it still seems to occupy a peripheral position within the investment management process at most wealth management firms, especially when it comes to portfolio construction.

Back in 2007 what is now Barclays Wealth and Investment Management caused a minor stir when it launched a new investment management process underpinned by behavioural finance principles.

The emergence of the global financial crisis, almost coincidental with the roll-out of the new process quickly diverted attention elsewhere. But ten years on the process is still pivotal to the investment management model that Barclays offers its wealth management clients. If nothing else this would suggest that it works.

In essence BWIM’s investment process uses its knowledge of investor psychology to generate returns that are consistent with both clients’ risk and emotional tolerance levels on a cost effective basis.

The reality is that left to their own devices clients often take action to reduce portfolio returns in the quest to achieve short-term emotional comfort. Discretionary investment management can provide a solution of sorts by absolving the client from making emotional decisions. But the outcome may still be emotionally unsettling (and not just for the client).

To provide an accurate means of identifying the ways that clients are likely to use to reduce their own returns in the quest for short-term comfort Barclays developed its Financial Personality Assessment (FPA). This marked a substantial shift from the traditional approach to investment portfolio design, which focused almost entirely on the client’s risk tolerance, and ignored other important factors that were more difficult to assess.

The FPA measures six different aspects of an individual’s personality, each of which relates to their financial behaviour and decision making.

“In essence, the FPA helps us to determine which emotional needs are most important to each client, and to identify which costs they are most in danger of incurring,” says Barclays. “We can only help investors get closer to their long-term financial objectives if we understand these factors at the beginning of the investment process, before they enter the market.”

Risk tolerance still remains at the heart of Barclays’ investment management process. But it also measures five other aspects of financial personality that enables Barclays to help get an investor close to their long-term optimum as possible. Three explore risk attitude. The other three relate to the investor’s decision style.

The three risk attitude components of the FPA cover risk tolerance, composure and market engagement.

Measuring risk tolerance helps to determine which combination of asset classes is optimal to attain the highest expected returns for the level of risk that an investor is prepared to take on.

Composure describes an investor’s emotional engagement with the short term, and the degree to which emotional responses may come to dominate long-term financial objectives.

“Investors with a high level of composure are relatively unaffected by the temporary ups and downs of the market, and can keep their focus on the longer term,” says Barclays. “They are less likely to over-respond to events and less prone to buying high and selling low.” 

Conversely, however, they can pay too little attention to market movements, fail to rebalance effectively and hold a cluttered portfolio of individual assets acquired over the years with no assurance that these function as an efficient whole.  

Market engagement refers to the ability to enter the markets in the first place.

But it also has extra dimensions.

Low market engagement can also create malign biases or inefficiencies because of the nature of the investments held, i.e. assets that feel familiar (familiarity bias), phasing investments in only gradually, giving up the premium that could be earned from holding low liquidity investments; paying for short-term protection etc.

High market engagement may indicate too much willingness to invest and a tendency to respond too enthusiastically to tips. Portfolios tend often hold investments that have performed well in the past, leading investors to buy high and chase performance.

The three decision style factors cover perceived financial expertise, delegation and belief in skill.

Perceived financial expertise is a measure of investors’ comfort with, and confidence in, their own ability to make good financial decisions.

Delegation measures the extent to which investors are prepared to handover decision making to a professional manager. This can reduce or increase anxiety depending upon the score.

As Barclays point out, however, personality dimensions can interact with each other in subtle ways.

“...a discretionary portfolio can help the high composure investor overcome inaction and apathy, and can do the same for a nervous investor who has low perceived financial expertise,” says Barclays. “On the other hand, the greater emotional distance from portfolio movements, decisions and details that come with delegation can also be useful in eliminating the short-term stress of a low composure investor. For those with a low desire for delegation, the solutions need to come from elsewhere and be more direct.”

The Belief in Skill element of the FPA examines the extent to which an investor is comfortable with paying for potential outperformance.

Those with high scores will want to seek out skilled managers to achieve higher returns and be more comfortable with tactical shifts to take advantage of medium term opportunities afforded by a changing environment.

Investors with lower scores are more likely to be uncomfortable with these efforts and more reluctant to pay a premium to get them. Stable asset allocations and index funds would be the preferred alternative.

But does it work?

Having finally taken the Barclays FPA it seems that it does, at least from a personal perspective.

The FPA certainly summed up my financial personality: moderate risk tolerance, composure and belief in skill; high market engagement and perceived financial expertise; low delegation.

“Your financial personality profile has produced measurements that are generally moderate to high on each scale,” says my assessment. “This suggests that you are likely to be comfortable with financial investing.

“Your financial personality means that you have a rational approach to investing and you are able to limit any emotional influences on your investment decisions. It is likely you will consider financial market investments and you understand that by participating in financial markets you have the potential to achieve greater returns but correspondingly greater risk of negative events.

“Your familiarity with finance will increase the range of investments that you would be comfortable investing in, giving you greater scope to invest in products that are appropriate for your risk level.”    

For the record I have self-managed quite a big investment portfolio for 40 years, have negotiated the traumas of the 1987 crash, the 2000 to 2003 bear market and the panic of 2008-2009 while remaining fully invested.

The portfolio consists almost entirely of equities with a global, as opposed to a UK focus. It also has both private equity and venture capital exposures via listed private equity funds and venture capital trusts (VCTs).  Turnover is very low. Apart from building a position in healthcare-related investment trusts over the past five years portfolio-related activity has been confined to reinvesting dividends in exisating positions. These are left to run with no attempt to rebalance. 

Over the past year it has generated a 41.5 percent return, 59.0 percent over three years and 124.8 percent over five years.    

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