When (you’re told) a new client wants a complicated investment strategy

The quandary

You accept clients from another advisor, who tells you the clients are sophisticated and wish to execute a relatively complicated investment strategy that you understand well. How do you proceed? 

The experts

Craig Machel Portfolio manager and investment advisor, The Machel Group, Richardson Wealth Ltd., Toronto

Speaking with the previous advisor provides background information on the client — personality traits, hot buttons, and what previously worked or didn’t work — but you can’t base KYC on this conversation. With a brand-new client relationship, you have to start from scratch and get to know one another regardless of whether the client is off the street or a referral from within the firm.

An advisor must understand the client’s expectations, risk tolerance, financial goals and how the client’s feelings about their money may change daily, weekly or monthly.

We offer alternative investments, and we spend time talking in depth with clients about risk and tradeoffs when investing. We assess their liquidity needs and risk tolerance, and we discuss the potential for losses in tough markets, quantifying a hypothetical loss in both a percent and dollar amount.

Clients must understand how they’re invested because a client will compare returns, asking why private assets, for example, aren’t moving up at the same pace as a quickly rising public market. (Private securities can offer stability and predictability when there is noise and chaos in the public markets.)

Taking on a new client is about more than a fit with our investment philosophy; I also look for personality fit between clients and our team so that we want to work with one another. I ask clients to tell me about their personal philosophies so we can see if our approaches to life align or would get in the way of an enjoyable relationship.

A new relationship offers the client a chance to start over. Maybe they weren’t comfortable sharing something with the previous advisor — they didn’t think the advisor would understand, or the advisor wasn’t a good listener. They can now say, “This is what I wanted, and I wasn’t getting it.” It’s an unveiling.

Sam Sivarajan Behavioural scientist and founder of The Goals-Based Advisor, a behavioural coaching and consultancy firm working with financial advisors and wealth management firms, Toronto

It’s not enough that a client says they want a certain strategy. Why do they want it? What is their experience with the strategy? Previously with the strategy, what were they invested in and when? It’s one thing to invest in a bull market and another to invest through a full investment cycle.

I most want to understand why the client wants the strategy. What are they trying to achieve? A doctor wouldn’t prescribe a drug because a patient asked for it; the doctor would ask questions and make a proper diagnosis.

A colleague once said he’d introduce me to a wealthy client but told me the client was only interested in talking about what would deliver annual returns of 15%. When I met with the client, I put those potential returns in a dollar amount and asked him what the money was for. That question changed the conversation. When he thought about what he needed the money for — to cover relatively modest expenses — he realized he didn’t need those big returns or the big risks that come with them.

KYC covers a regulatory obligation and also protects the advisor, firm and client, and makes sure the solution being recommended is in line with what the client needs. That’s the foundation for a long-term relationship, which reduces client attrition and reflects what a client wants. From interviews with investors for my doctoral thesis in behavioural finance, I learned that investors want KYC to be more engaging and fulsome concerning their needs and goals.

KYC isn’t about one question; it’s about the next question and the next. It’s asking open-ended questions, actively listening to the answers and digging further to make something clear.

KYC is also not one and done. Clients’ lives, outlooks, priorities and preferences change. KYC is an ongoing effort of investing in a relationship and keeping abreast of what’s important to clients.

Disciplinary consequences

In a know-your-client/suitability case highlighted by the Investment Industry Regulatory Organization of Canada in its latest enforcement report (2021–22), an advisor accepted several client referrals from another approved person, who said the clients were sophisticated and wanted to trade in options on commodities futures.

The advisor “assumed the clients understood the risks and failed to make appropriate inquiries of the clients or inform them of the scope of the risk involved in the strategy,” the report says.

During a period of market volatility, the clients lost US$1.36 million. IIROC banned the advisor for a year and fined him almost $140,000 including costs.