KYC in a dangerous time

In good times, advisors go to great lengths to remind clients that the party won’t last, and to tease out how clients will feel when portfolios lose 20% of their value.

“Complacency can set in,” says Darcie Crowe, investment advisor and portfolio manager at Canaccord Genuity Wealth Management in Vancouver, describing the “greed phase” of the market after a decade-long bull run.

“Investors push beyond what their true risk tolerance and comfort level is because of the fear of missing out,” she says.

Advisors have various methods to push back, but none as visceral as the real thing. In that sense, the economic fallout from Covid-19 presents a rare opportunity to review clients’ risk tolerance.

“Now people really know their feelings,” says Blair Corkum, a fee-based financial planner who runs Blair Corkum Financial Planning Inc. in Charlottetown, P.E.I. “We all know how brave we are when times are good.”

Understanding how clients feel during drastic market movements will help avoid situations where a client who’s outside their comfort zone insists on selling in a market trough, Crowe says.

“The only way you’re going to be able to do that is to have these honest conversations about risk tolerance when they’re actually in that period of distress — to paint that more realistic picture about how they feel,” she says.

There are also urgent, practical reasons for reviewing know-your-client information now. In addition to portfolios suffering as markets tanked in March, clients may have lost their jobs or become ill during the pandemic. Such changes could significantly affect clients’ retirement goals, time horizons and risk tolerance if cash is needed immediately to make up for lost income or another emergency.

“This economic shutdown has been so extreme that there are material changes for a lot of clients and it’s the advisor’s job to uncover those changes and be aware of them,” Crowe says.

She has a client in the hospitality sector for whom it could take years before income returns to pre-crisis levels, so she may need to make portfolio changes to accommodate income requirements and adjust the client’s retirement plan.

As urgent as those conversations are, there’s a downside to adjusting risk tolerance at such a vulnerable time, says David Lewis, chief client officer at behavioural economics consultancy BEworks in Toronto.

Most clients are feeling anxious and prone to a “scarcity mindset,” Lewis says — prioritizing immediate needs over future ones; focusing on past losses rather than potential gains — and less capable of rational thought.

As a result, clients will be much more risk averse than normal, he says.

“Clients who’ve had a significant change in circumstances where their risk preference should go down or should go up — that’s a great time to have that risk preference conversation,” he says.

“But the advisor should also be cognizant of the fact that everyone’s risk preference will have shifted downward to the global pandemic context. In some cases, that may not be realistic.”

For example: a client who wants 10% returns without any risk. The advisor’s value, Lewis says, is being able to explain the trade-offs between low-risk investments and retirement goals, and putting market crashes in context.

If a client’s panicking now, Corkum says, it could be because their risk profile wasn’t quite right.

“The real-life feelings are there now to discuss,” he says.

“If they’re saying they can’t sleep at night, we need to modify that profile.”

Timing is important. While taking a client’s concerns seriously, advisors still need to avoid selling off risk assets in a downturn.

“While we need to tone [clients] down when they’re in euphoria, we need to build them up when they’re panicked,” Corkum says.

Advisors can help clients manage their liquidity needs and put off the broader risk discussion for a less emotional time.

A few months from now, when markets have (hopefully) recovered, advisors can refer back to how clients felt during the downturn and look at restructuring the portfolio then, he says.