Suitability is the process by which wealth managers ensure investments are appropriate for a client's goals, risk tolerance, and capacity. It has come under increased scrutiny as some firms treated it as a box-checking exercise. The Financial Conduct Authority is working to ensure clients get what they expect from investments. Wealth managers must understand all factors that influence suitability, including a client's need for risk, capacity for loss, risk tolerance, and time horizon. While risk and suitability are linked, suitability encompasses more than just volatility. Wealth managers must take practical steps like ensuring a common understanding of risk with clients and monitoring portfolios against the client's mandate.

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2 minute guide
to suitability
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2. what is suitability?
»» In simple terms it is the process by which wealth managers establish whether the
investment proposition they put forward is right for a client.
»» Wealth managers must ensure that investments made on behalf of a client are consistent
with the client’s goals, that the risk of the proposition offered is appropriate for the
client’s circumstances and whether the client has the capacity and tolerance to deal with
the risks involved.
why is it now under close scrutiny?
»» The industry’s attitude to the definitions of high, medium and low risk had barely
changed since the mid-1980s and even post the guidance paper issued by the Financial
Services Authority (FSA) in March 2011. Risk profiling was seen by some as a tick box
exercise, which resulted in there being disparities in the depth and consistency of the
approaches taken by some firms in the sector.
»» To deal with the disparities in depth and consistency in the approaches taken over the
years, the Financial Conduct Authority (FCA) has put suitability at the top of its agenda.
Its main thrust is to ensure that clients get what they expect from their investments and
wealth managers are better placed to manage these expectations.
»» Today, portfolio risk management is seen as a fundamental part of the investment
process both by private investors, who take far more interest in the risk management
systems of investment companies and its influence on suitability, as well as the regulator.
»» As a result the bar has been raised. Many wealth managers are now looking to replace
their paper and excel based solutions for the efficiency, and audit and control gains
specialist automated systems can offer.
what elements influence suitability?
»» Need for risk. There is a fundamental question that has to be asked: How much risk
needs to be taken to achieve the client objective? This might mean that more (or less)
risk has to be taken than the client’s tolerance to risk has indicated
»» Capacity for risk (or more specifically loss within the time horizon). Simplistically, how
much can the client afford to lose before it has a material impact on the objective or,
wider still, the client’s actual lifestyle?
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»» Tolerance of risk. There is a balance to be reached between the discomfort of holding a
higher risk portfolio in a fluctuating or falling market and the risk of regret of holding too
conservative a portfolio in a rising market.
»» Time. Given enough time markets will recover. However, recovery might not happen
within the limited time horizon of the client. Ascertaining how much time the client has
can be the biggest limiting factor on any risk to be taken.
are risk and suitability synonyms?
»» Perhaps the biggest risk facing any suitability decision is the failure to meet client
expectations. In that sense, risk and suitability are tightly linked.
»» Portfolio risk management and risk based portfolio construction should always be guided
by the client risk profile they look to serve. Each of these elements is of fundamental
importance when assessing on-going suitability but they alone do not cover the full set of
influencing factors.
»» To that end, although volatility is a powerful proxy for many risk measures, it does
not capture all the risks within a portfolio and nor does it ensure suitability. However,
monitoring volatility does help manage the two suitability elements of capacity and
tolerance for risk.
what practical steps do wealth managers need to
take in response?
»» Ensure a common understanding with the client about portfolio risk in its own right, risk
in the context of loss and risk required to achieve the objective.
»» Understand the risks in the portfolio, its components and construction.
»» Monitor the portfolio against the mandate set and adjust course along the way.
»» Have sufficiently robust systems and processes in place that tie in suitability across
the client’s time horizon, from the point of onboarding through to the end of their
investment period.